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CEF Market Review: September Review

Tom Roseen
Tom Roseen, Head of Research Services with Refinitiv Lipper & author of the Fund Market Insight Report alongside the Closed-End Fund Association discuss Tom's insights on September's closed-end fund market. 



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 Merritt. Today we are joined again by Tom Roseen, Head of Research Services with Refinitiv Lipper, and author of the FundMarket Insight Report, which provides in-depth monthly commentary on the closed-end fund market. We're happy to have you with us today, Tom.


Hi, Diane, good to be here. Thanks for having me.


Tom, you recently published your report for August 2020 covering over 500 closed-end and interval funds. How did markets generally perform in August, and what was the impact on closed-end funds?


Well, it was a really strong month for equities, and I think most people know that we had one of the strongest Nasdaq returns for an August in almost 30 years. It reported a 9.59% return for the month. So really spectacular.

On the tax-exempt side for municipals, they really struggled. We saw some negative numbers, and they're kind of in the middle of the area. We did have about half of the bond funds actually do pretty good. What was happening though, is people were weighing the continued cases of COVID-19, with opening of schools, and we heard that some of the schools actually two weeks after they opened, they closed again. And so people were concerned about that. Particularly, people were concerned about the government impasse concerning the emergency unemployment package that we've been working with here recently. And they weighed that against the Federal Reserve›s commitment to support the economy. It's been all the way saying “we'll do whatever it takes”. And I think the biggest news was the improvements in the unemployment rate. We saw 1.76 million new jobs added last month, or the month prior to that actually, and the unemployment rate dropped to 10.2%. So it was really quite good.

But again, what we saw was equity funds for the fifth month in a row, basically rise. For August, we saw 2.71% return on a NAV basis, and we saw 3.59% return on a market basis, but year-to-date, they're still down 7.56%. And on the fixed income side, we also saw, for the fifth month in a row, plus side returns, but this time we saw for August a 0.73% return for fixed income funds on a NAV basis, and a 0.64% return on market, and year-to-date they're down just one, two percent. So really it was a good month, not so strong for the fixed income side of the universe, but very good for the equity side of the universe.


Your data breaks out closed-end funds into over 20 classifications. What classifications were the best performing for the month, and which sector struggled?


Well, let's take a look first at our macro groups. When I told you how equities did and fixed income did, we saw about 86% of all equity funds posting plus side returns. That's first. Second of all, I did make mention to it already, but fixed income funds only had about 58% that were winners. But for the fourth month in a row, we saw that world equity funds stayed at the top of the universe group for equity funds, world equity funds returned about 3.86%. Mixed asset funds returned about 3.61%, and domestic equity funds returned about 2.10%.

We take a look at the equity side and kind of narrow down on that, we see that convertible securities for the second month in a row was a top performer, 5.76%. And remember I was talking about this maybe last month when we were chatting, we saw that the convertible securities, they have this ... fair yield that they pay out, but they also benefit a lot when markets are rising strongly, and they did rise strongly in both the preceding two months. So this might be a game changer as we go into the month of September. But 5.76% for them. Developed market funds had a wonderful 5.21%. And diversified equity funds even had a return of 4.28%. At the bottom, however, we see utility funds only produced a 0.05% plus side return. And real estate funds were the group that bettered the utility funds, and they returned about 0.63%.

If we take a look now at fixed income, we know that the treasury came out, and actually the treasury curve actually shifted up after the Fed announced a new inflation policy. It basically stated that it's going to let inflation run a little hot. What they've done in the past prior to this new rule is that it got close to two percent, or they were concerned about it entering the two percent range, and had already started hiking rates. They're going to go ahead and let it run a little hot. Let employment get a little hotter than they normally would, before they make any hikes. So they're going to allow the two percent rate to actually go above two percent, and then make the hike. So it won›t be a preemptive attack.
So, we saw this actually weigh on some of the quality issues. So, the treasury issues we saw it weigh on the muni bond fund side. In fact, fixed income funds, domestic taxable fixed income actually were up 1.63%. Pretty handsome. World fixed income funds were up 1.51%, and then muni bond funds for the first month in four actually had negative returns, 0.53%.


And is this a change in what you saw from July?


It is. We basically saw a change, and again, as I was saying ... You know what? Let me take a step back there, Diane, as well, because what we saw was loan participation funds actually do much better. And the reason I bring this up afterwards now, we saw 1.89% return for this group. And this is usually people looking at inflationary concerns, right? Because it's an adjustable rate mortgage type of thing. It's not a mortgage, but adjustable rate loans that are out there, bank loans. And it was a 1.9%. It's first month in nine. They actually went on to the top. And U.S. mortgages actually were at the top as well, 1.82%.

So the change we saw this month was basically for ... Equity funds did exactly the same. Everybody was powering on. We saw convertible securities do well, but where we saw the drastic change was in the fixed income closed-end fund universe. Again, that was one of the big changes we saw. And I didn't mention that for the muni bond funds, all nine classifications were in negative territory, and that's something we haven't seen for at least four months. And then, also the bottom of the barrel was the California municipal debt. So really the group that struggled here, the change that we saw was, again, the fixed income side, particularly on the tax exempt side of the business.


Are you expecting these trends to carry over into September?


Big changes are afoot. We've all seen the huge market meltdown. Big tech is actually dragging down just about everybody. In fact, today is Tuesday, and we are seeing the continuation of the meltdown we saw on Thursday and Friday. The big one was on Thursday. But we're basically looking at people, probably wanting to move into, let's say, safe haven plays for awhile. So we're going to see, for instance, big dividend payers probably do better. We're going to see maybe some people jumping to gold if they duck for cover. So these are some of the issues that we've been taking a look at here recently.

CEFA: Closed-end funds can trade at a premium or discount to net asset value. What were the trends in premium discount behavior?


We saw the median discount for all closed-end funds in August narrow about 15 basis points. Again, remember it was a really good month for equities. So, basically saw it decline to about 8.56%, and that is worse than, and still remains worse or wider than the 12 month moving average median discount of 7.73%. So, when we take kind of a deeper look, that was for all closed-end funds, equity funds improved about four basis points to 11.92%. And then we saw fixed income narrow about 11 basis points to a 7.19% discount for the group. And again, these are all medians. If we use an average for people, if they're thinking, why are they talking about medians? When we use averages, there's some funds that have some huge outliers, right? They have really big discounts, really big premiums. We try to take out those outliers. So we use the median.


How do premiums and discounts compare to their historical averages?


They're still significantly wider than they were a year ago. For instance, remember I told you that the median discount for all equity funds and fixed income funds combined was 8.56%. If we go back to September, 2019, a year ago, it was at 6.42% for all funds in equity and fixed income. There was 101 funds, basically, trading at a premium at that time. And you know, that's changed quite a bit. Equity funds, as far as the discount goes, it was at 6.39% in September, with 50 trading at a premium. And then we saw fixed income funds, basically at 6.46%, with 51 of those funds trading at a premium. And if we take a look just ... I won't go through all the numbers again, but if we take a look at the numbers right now for all closed-end funds, we're basically looking at 77 funds that are trading at a premium. That was as of August 31. So, big change as far as difference between a year ago to today. And certainly it has a lot of room for improvement.


So, which sector saw the greatest change?  


Well, we thought again, this is where people were actually looking for yield. So we saw high yield closed-end funds, and of course they also moved well with equities. Equities had a great month last month. Largest narrowing of discount occurred for high yield funds. Basically, 222 basis point improvement to 7.48%. And then we saw that the national municipal bond fund macro group saw the largest widening of discounts. As I told you they were in negative territory last month. They dropped about 123 basis points to 6.80% on the median discount for that group.


Tom, we are now moving into Fall. Areas of the economy are improving, but there are still some economic uncertainties, and we have an election in about two months. With that backdrop, are there sectors where investors may find particular opportunities given where those funds are trading relative to their historical averages?


I'm still going to say yes as we've been talking about. I think we need to expect a lot of volatility to come out there. Although, I think if most people think about back to election years, because nobody wants to do anything real big and make big changes. The Fed stays out of it really, as far as if there was going to be a hike or a decline in rates, they usually wait so it doesn't impact the presidential election or the actual election that's going on. But I still expect a lot of volatility to go on. Markets are down, as I said before, they continue to be down over the last three or four days. So, I think that we're going to see big tech stocks taking a hit.

But investors still are going to be searching for yield. And so I think there are some opportunities. If we look at, for instance, one of the best performing categories, again, I think people turn to quality when there's times of tough things. So, the quality areas, Triple B or better. So we'll see our Triple B funds, they're actually up 5.88% for the year so far, but I think there is some possibility there that quality will be a place people are going to on the fixed income side.
And then we may even look at some of the big losers here recently. Again we're looking for yield. We saw that the real estate has been doing really good ... Well we'll see what this recent meltdown has done. But they're down 7.61% for the year so far, still. And we see utility funds are down 11.23%. So it might be that opportunity to buy those. Also, people looking for that opportunity, they might even be able to buy some of the big losers out there. Natural resources and the like.

This is an opportunity to buy on the dip. But again, I'm a little cautious here, just because we were still concerned about Coronavirus. We're still concerned about the presidential election coming up. We're still worried about the bailout for unemployment. And many people are concerned about this unemployment package not getting passed because of such strong unemployment numbers that we had that came out just recently. So I think people are going to keep an eye on it. When the unemployment rate drops to 8.2% from 10.2 ... I'm sorry. It was probably 8.4. I'm doing this from the top of my head. But when you see that type of an improvement, there's not a lot of catalyst for either side of the parties to actually push through another package. So I think people are a little concerned there. So I keep an eye out on that. But again, quality I think is going to be the name of the game here.

CEFA:  Tom, you also follow interval funds which typically offer limited quarterly liquidity to investors. How have interval funds generally performed so far this year?


When we look at these, I like to look at the five categories, or six categories that we know there's a lot of equivalent funds. So what I mean by equivalent funds, we have the interval funds are almost equal to the number of conventional funds. So we see real estate sector equity, loan participation funds, and preferred stock is where these funds have done a better job mitigating losses. Let me give you an example here. We saw that for real estate funds, and I mentioned them just a second ago, they're down 16.06%, basically for the year-to-date return. And that is on the conventional fund side ... Conventional closed-end fund side. If we look at the interval funds, they're only down 4.70%. So, they've done a better job of mitigating losses.

On the flip side, if we look at the general bond category, they've actually done a worse job mitigating losses. We see that the conventional closed-end fund was down about 1.20% for general bond fund group, where it was down 3.68% for the interval funds. So there has been a mixture there, but in four of the six categories that I consider to have large representation in there, they've actually beat their conventional closed-end fund brother.

CEFA:  Do you see interval funds as an interesting option for investors looking for higher yielding investments?


I do. And I think every time I talk about interval funds, I have to bring up the issue that it's a long-term investment. When you get into this, this is nothing you're going to get in and get out, because interval funds have a limited amount of times that they can actually ... that you and I can actually redeem our shares. Usually it's quarterly. Some are semi-annual, or even annual. But most of them are quarterly. And again, they're only required to do between five and 25%, whatever they state in their prospectus language. But, they also in most cases, they don't have to do any sort of redemption.

But, let's get back to the question. So yes, I think there are some yields where you can get a higher yield from, because they're allowed to go into, let's say, the private equity placement, or in a private placements, or into bond funds that you and I normally couldn't buy on the market. They're able to do that through private placements. So we're able to get a bigger yield and they're able to go after those bigger yields, as that yield curve, let's say, moves up. In this flat interest rate environment, and we expect it to stay flat for some time because the Fed's said they're not going to do anything. They're not even thinking about doing anything as far as hiking rates. This is an opportunity for us to be in a long-term higher yield instrument. But keep in mind, again, there is a caveat. You can't sell when you want to and flip it. There's some illiquidity issues that we need to pay attention to when purchasing interval funds.

CEFA:  How do you see these funds benefiting an income-oriented investor if they're concerned about market volatility?


Well, it would stop me if ... When I'm in an interval fund, it stops me from selling my security, because I can't sell it anyways. So, that can be a good thing during market volatility, when you get some big swings and maybe you might let psychology come into your buy and sell decision. This will take that piece out of there. And so, there really is a benefit also that managers don't have to sell. And this is more towards the open-end universe, comparability, but there is no issue for them to actually have to go out there, or pressure for them to go out there and sell a security to cover redemptions.

So again, the closed-end funds, and this is true for all closed-end in funds, but the closed-end interval fund also has the ability there ... again, be in those private placements and not have to worry about whether they're marking to market, let's say, for trading purposes on a regular basis. So again, I think there are some benefits. And again, I would be ... caveat is just be very cautious with these as a long-term investment, and a long-term investment only.


Tom, thank you so much for taking the time to join us today.

 Tom:  Pleasure to be here, Diane. Thanks.

Audio recorded 09/08/20.


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.


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