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Managing Through the Volatility with Closed-End Funds

Aberdeen Standard Investments




Rennie McConnochie

Rennie McConnachie, Head of Global Banks and Josh Duitz, Portfolio Manager with the Global Equity team with Aberdeen Standard and the Closed-End Fund Association discuss managing the volatility among closed-end funds and identifying opportunities in the current market as part of CEFA›s CEF Insights podcast series. The podcast audio can be heard here.

 

CEFA: Welcome to CEF Insights, your source for closed-end fund information and education brought to you by the Closed-End Fund Association. My name is Diane Meritt. Today we are joined by Rennie McConnochie, Head of Global Banks, and Josh Duitz, Portfolio Manager on the Global Equity Team with Aberdeen Standard Investments, and their family of 10 US closed-end funds. We're happy to have you with us today.

Josh: Glad to be here.

Rennie:
Yeah, thank you very much for having us on.

CEFA:

Rennie, Aberdeen Standard is a global investment manager and you work with financial institutions in all world markets. We are in a difficult and unusual economic environment. Are the global markets at different points in dealing with the Corona virus and the associated economic impact?

Rennie: Yeah. First and foremost, Aberdeen Standard Investments hope that we get through this as quickly and as soon as we can and as safely as we can. In short, the answer to your question is yes. Different countries are at different stages of the coping cycle, for lack of a better expression. We are seeing some countries in Asia, China in particular, talking about coming out of lockdown. It's even being discussed in one or two areas in Europe. Other countries like the U S and also a significant number of other emerging markets countries are nowhere near coming out of lockdown and in some cases haven't even got into it yet. So different countries are at different stages of the cycle.


The one thing I would caution though is in some of the countries that are attempting to come out of lockdown like China, Hong Kong, South Korea, some of these countries are now seeing secondary infection rates start to tick up again. It's been the same in Singapore, so I think we need to really keep a close eye on that, because I think countries that haven't come out of lockdown like the US could learn a lot for how that cycle plays out. So we are keeping a very close eye on infection rates in those countries coming out and lock down.


In terms of the economic environment, it will be shocking over the next few months, of that there is no doubt. We really don't know how bad yet, it's too early to say, but if you look at a lot of world economies the consumer is about 70% of GDP and consumer spending has all but stopped. So the economic impact is going to be very significant. Whilst there's a lot of debate about whether we will see a V shaped or a U shaped recovery, I think a lot of the commentators around are very much moving towards a U shaped view of the world, which means that yes, we'll get recovery, but it'll be some way out, and it will be a lot more gradual than a lot of investors had originally thought.

CEFA: What has been the general impact of this market volatility on closed-end funds and has this impact been similar to what we see in the broader market or more extreme?

Rennie: Closed-end funds have undoubtedly been hit very hard. Not only do you have the correction through NAV as markets fall in equity land or spreads widen in credit land, so you obviously have that impacted on NAVs, but over and above that what we've also seen has been a significant widening of discounts in a lot of closed-end funds, so that only adds to the financial pain that's being felt in the very short term by a lot of closed-end fund investors. So discounts up until a few weeks ago had actually been quite tight in the market, depending on the various areas of the market you were looking at, anywhere between two, three and 4% discounts, some funds trading even tighter than that.


Those discounts have blown out very widely now and seeing discounts of 20%, 25% or 30% was not uncommon at the worst of markets. Over and above that, you've had a number of funds have announced changes to their distribution policies, and so distribution rates have been cut, and we've also seen some funds run into some bother with leverage, and that too has just magnified the under performance of the share prices. It's been a pretty tough week or weeks for the closed-end fund universe.

CEFA: Is this volatility presenting opportunities for closed-end fund investors with a long-term outlook?

Rennie: The answer to that is definitely yes, and whilst none of us are clever enough to pick the bottom in terms of markets, I think investing in a safe portfolio of closed-end funds with discounts where they are at the moment and NAVs where they are the moment, could well make a lot of sense. You've basically got to look for well managed equity funds, well managed credit funds, well managed municipal funds, those trading at a significant discount to NAV, those with conservative distribution policies. I think with share prices where they are at the moment, a long-term investor could lock in to some very attractive income streams, and I think that's very important, because we are quite clearly even deeper into a lower for longer interest rate environment. So being able to invest in a well-managed conservative portfolio of equity or credit assets at these levels could lock in some very significant income streams going forward.


So I think there are opportunities. I stress, again, calling the bottom of the market is a mug's game. We would certainly not endeavor to do that, but taking a long-term view there is clearly quite significant value in the markets at the moment.
 
CEFA: Josh, Aberdeen Standard has a long history of managing investments and particularly closed-end funds through market cycles and shocks. What advantages do you see in managing a closed-end fund through periods of volatility as compared to other product structures?

Josh: I would say the biggest advantage right now to managing a fund in the closed-end fund space is the fact that you have a stable capital base, and what you see in open end funds is investors start running for the doors when the market starts selling off, and then as a fund manager, you're forced to sell. Being there's a stable capital base for a closed-end fund, you're not a forced seller. And if you have stocks that you'd like for the long-term, you're not forced to sell them at the wrong point in time.


Now, the one caveat to that is if you have a significantly levered fund and then you might be a forced seller when the market sells down. The two funds for instance that I manage, AOD and AGD, both as of the end of February,  we were not forced sellers during this period at all, which I think is extremely helpful, if you're investor for the long-term.

CEFA: Josh, you manage Aberdeen Total Dynamic Dividend Fund and Aberdeen Global Dynamic Dividend Fund, symbols, AOD and AGD. Are you seeing opportunities in the equity markets after the uncertainty we have experienced?

Josh: Yeah, and I'd like to take a step back, at first. Just understand what's gone on over the past month or six weeks. The speed and magnitude of the decline is absolutely unprecedented. Shutting down economies we've never done before, which has already led to a stark rise in unemployment, and we are definitely in a recession already globally. But also the fiscal and monetary support is also unprecedented. And for the short term and hopefully for the long term that is helping out the markets. I think as of now there's about $10 trillion of fiscal support announced by different governments, and what has happened during this time period is there's been great dislocations in the market, because there's been indiscriminate selling, and it started out because of the sentiment of the virus, and now it's really on macro.


And when you have that indiscriminate selling and the market's moving on macro data it really becomes stocks moving together in a high correlation between different stocks, and I think that's really where the opportunity lies, when you have this high correlation, even though the companies are different, the balance sheets may be different, and that's where it really presents opportunity to buy.

CEFA: Are there particular sectors or markets you find compelling?
 
Josh:  It's interesting because at Aberdeen we're really fundamental bottom up investors, but as I mentioned, you are seeing this high correlation between sectors and markets, and clearly there are certain sectors who are going to fare better than others. For instance, we're going to see large negative revisions to earnings on industrials and energy, besides what's going on because of the Corona virus, but also because of what happened in OPEC and energy. Where we'll see more stable sectors on the earnings front in utilities and healthcare.


So when you see the whole market trading down, and sectors moving eight, nine, 10%, we really like to identify different companies in there who really should not be selling off as much as others because of their earnings profile, and when you see utilities down as much as an industrial company, I think that's where we really look for those types of opportunities to buy, and also on the flip side to sell when we believe that companies haven't sold off as much as they should. It's not only on individual sectors, but you also see that in countries, and I'll give you an example. In Italy for instance, when everything started happening in Italy, when the Corona virus really took hold there, and you saw the peak of it and the death rates coming through. You saw the market selling off, and everything in Italy was selling off, but there's still individual companies there who will be less affected by the Corona virus and the outcome of it, and that again presents an opportunity to buy different companies.


So we're looking at it both on a sector and country basis, but really looking at a fundamental basis of the type of companies we want to invest in.

CEFA:  Is Aberdeen Standard›s active management approach an advantage in these types of market environments?

Josh:  I think it's a huge advantage to be an active manager here. It might not show over the next week or two weeks because of the high correlation of the markets, but when you could identify companies that over the long-term will outperform because we've done the work, that we understand the balance sheet, and we understand the income statement, and the liquidity of the companies, we're taking a look and making sure none of the companies that we own are going to violate their covenants and there›s moats around the business, we think those types of companies will outperform over the long-term. And we use this as an opportunity to make sure that we›re comfortable with our portfolio and to continue to invest in those types of companies.


I definitely caution against being hyperactive and hyperactive trading during these time periods because of the volatility. You have to be disciplined and you understand the companies and the companies that we own have gone through these types of cycles and those are the types of companies that we want to own for the long-term. So those are the real opportunities to stick to our fundamental approach to investing and identifying good companies to own.
 
CEFA:  Rennie, Aberdeen manages both equity and fixed income closed-end funds investing in global and emerging markets. How do you see these products being best positioned in the diversified portfolios of investors?
 
Rennie:  Well, I think it comes back to what one is expecting closed-end funds to deliver and there are a number of attributes to the investment vehicle. One is clearly the delivery of superior income, and that will remain important in investor's eyes going forward. I touched on that earlier. And also, the beauty of the closed-end fund wrapper is it does allow investors to get exposure to less liquid markets within a fund structure, as my friend Josh referred to earlier, that doesn't have to deal with managing redemptions. And certainly, in areas of emerging markets where you do see less liquid holdings in terms of equities or bonds, that fund wrap structure has served an excellent purpose.


So a diversified portfolio will probably contain ETFs for beta, some open-ended mutual funds. The closed-fund vehicles would serve to provide a portfolio with income and perhaps less liquid exposures and then a portfolio may have some exposure to the private markets as well. And what we've seen increasingly over the last few years is that the closed-end fund structure either listed or unlisted has become very popular in terms of providing private markets exposure. So closed-end funds should never be 100% of anybody's portfolio, but they certainly have a very important role to play in diversifying a portfolio, and providing income streams to that portfolio, and also providing exposure to less liquid investments in a watertight fund structure.
 
CEFA:  Rennie and Josh, thank you both so much for taking the time to join us today.
 
Josh: Thank you for having us.
 
Rennie:  Thank you very much for having us. Thoroughly enjoyed talking to you.
 
CEFA:  And we want to thank you for tuning into another CEF Insights podcast. For more educational content, please visit our website at www.cefa.com.
 


Audio recorded 04/28/20.


Important Information

PAST PERFORMANCE DOES NOT GUARUNTEE FURTURE RESULTS.

Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund›s investment return and principal value will fluctuate so that an investor›s shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund›s portfolio. The Net Asset Value (NAV) is the value of an entity›s assets less the value of its liabilities. The Market Price is the current price at which an asset can be bought or sold. There is no assurance that the Fund will achieve its investment objective.

Closed-end funds are similar to mutual funds and exchange-traded funds (ETFs) in that they professionally manage portfolios of stocks, bonds or other investments. Unlike mutual funds and ETFs, which continuously sell newly issued shares and redeem outstanding shares, most closed-end funds offer a fixed number of shares in an initial public offering (IPO) that are then traded on an exchange. Open-end funds can be bought or sold at the end of each trading day at their net asset values (NAVs). Because closed-end funds and ETFs trade throughout the day on an exchange, the supply and demand for the shares determine their market price; closed-end funds› and ETFs› market prices may fluctuate through the trading day and those prices may be higher or lower than their NAVs. Closed-end funds, mutual funds and ETFs charge investors annual fees and expenses. All of these products may use leverage to enhance their returns, which can magnify a fund›s gains as well as its losses. Closed-end funds typically do not have sales-based share classes with different commission rates and annual fees. All three vehicles seek to deliver returns based on their investment objectives, but none of them are FDIC insured. The Revenue Act of 1936 established guidelines for the taxation of funds, while the Investment Company Act of 1940 governs their structure. Aberdeen Standard Investments does not provide tax or legal advice; please consult your tax and/or legal advisor.

Diversification does not ensure a profit or protect against a loss in a declining market. 

The use of leverage will also increase market exposure and magnify risk.

The above is for informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. Aberdeen Standard Investments (ASI) does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials. 

Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make his/her own assessment of the relevance, accuracy and adequacy of the information contained in this document, and make such independent investigations, as he/she may consider necessary or appropriate for the purpose of such assessment. 

Any opinion or estimate contained in this document is made on a general basis and is not to be relied on by the reader as advice. Neither ASI nor any of its agents have given any consideration to nor have they made any investigation of the investment objectives, financial situation or particular need of the reader, any specific person or for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document.


Disclosure

Closed-end funds trade on exchanges at prices that may be more or less than their NAVs. There is no guarantee that an investor can sell shares at a price greater than or equal to the purchase price, or that a CEF's discount will narrow or be eliminated. CEFs often use leverage, which increases a fund's risk or volatility. The actual amount of distributions may vary with fund performance and market conditions. Past performance is no guarantee for future results.


Resources

Aberdeen Closed-End TV

Asset TV — CEF Channel

CEF Connect

Cohen & Steers CEFs Knowledge Center

Harvest — CEFA Channel

Legg Mason CEFs

Seeking Alpha — CEFA Channel


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