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


Thanks for having me, Diane. Good to be here.


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


Well, we had kind of an up and down market this month, or I should say last month, in July. We had a couple of things to contend with. First of all, we saw that the number of coronavirus cases actually rose and were new records, we heard each and every day, Florida and Texas had a new record set each day. We also had some concerns about action on Capitol Hill and actually turned out to be inaction on Capitol Hill, where we were hoping that they would come up with a package that would help those guys that are unemployed right now with the Extended Emergency Unemployment Package, which would have given them the extension after July 31st, that $600 a week. Well, we found out that that didn't come to fruition, of course, we kind of went back and forth mid-month on that.

But what we were weighing this against was actually some rather good news, we saw an improvement in nonfarm payrolls, we had in June a 4.8 million addition of new jobs. Well, we all know it's not new jobs, it's just people who are furloughed finally coming back. But unemployment rate dropped from like 13.5% to 11.1%, so that was good news. We heard another commitment from Jerome Powell and his team basically saying that they'll do whatever it takes to support the economy, so we had that commitment. And then last, and certainly not least in this case, we had better than feared Q2 earnings reports. This is really, really good. So, I think a lot of people expected a lot of bad news coming out of corporate America and, in fact, we all know it was revised downward and so the expectations were very low, so they beat a very low hurdle. But I mean, we saw the NASDAQ returned 6.82%. And we take a look at the closed-end fund universe, we see the closed-end funds benefited quite handsomely this month from it.

Equity funds, on average, on a NAV basis were up 3.42%, on a market basis, about 3.35%. We saw fixed income closed-end funds come in about 2.81% for the month. On a market basis, it was up a whopping 4.08%. And when we take a look at winners and losers, 84% of equities funds posted plus side returns, 98% of fixed income funds posted plus side returns. And if we take a look at the last three months, equity funds are up 9.54% and the fixed income funds are up 10.51%. So, really it was handsome returns all the way around, but there was volatility to contend with.


Now, 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, we had an interesting case because people were concerned. So I generally don't call out any particular funds in general in this conversation that we have Diane, basically what we did see, and this is important just because of where it went in classification, there's no real classification for it, ASA Gold & Precious Metal Fund was up 22.55%. So, despite the market rise, investors were still a bit nervous and still a bit risk averse and so we saw like gold and out of favor issues actually do better than we had anticipated, I guess, for the old issues just because we were watching this tear for the FANG stocks, the NASDAQ was doing just great.

Treasury curve shifted down, so this is what caused a little bit of a strange piece. So I told you, we had out of favor issues, treasury curve shifting down, so we saw actually bond funds actually do better in some cases than equity. But our macro groups, when we take a look at our macro groups, for the third month in a row, we see world equity funds at the top of the group. Now, when I call it macro groups, I don't know if I've ever defined this, but we have domestic equity macro groups, we have mixed assets, and then we have world equity. Well this time, world equity was the top of the game, 5.08%. They outpaced their mixed asset and their domestic equity counterparts. That's the same for world fixed income closed-end funds as well, they were up 3.05%. And, again, just to go through it so people know what we're talking about. We have domestic, taxable fixed income, we have municipal bond funds, and then we have world taxable fixed income. Well, they were the top leaders in their groups. So they beat the municipals and also the other taxable bond funds.

But let's focus down a little bit on the classifications themselves. Convertible securities were the big winner this month. So for July, we saw that they had a 7.39% return. Remember convertible securities are bonds with a kicker on it that if you believe there's going to be growth in the underlying stock, they convert into stocks. Well, guess what? We've had such a go-go market going on, markets going up, convertible securities did great, 7.39% top performer.

Emerging market funds actually came in the next winner from equity side, 6.24%, and utility funds, no longer your mom and pops utility funds by the way, they're a good yielder, and basically came up 6.07%. And if we look at fixed income side of the universe, kind of the same thing, but a little bit more risk seeking here. High yield leverage funds are up 4.18%, we had a corporate debt Triple-B rated leveraged funds up 3.94%, and emerging market hard currency debt up 3.55%. So, all in all really we saw some good numbers there.

And on the bottom of this list, we saw the energy master limited partnerships, we've been talking about them, they're down about 58% for the year still so far, for the month of July, they were down 0.72%. And at the bottom of the fixed income list, we basically saw intermediate municipal debt funds at the bottom of the group, but they still posted a 1.04% return. So, all really good there, all nine municipal classifications for the third consecutive month posted plus side returns in July.


Is this a change in what you saw from June?


So it's the same trend on equity side, right? So, we saw that the kind of energy, natural resources right at the bottom, we saw energy master limited partnerships at the bottom, but everything else, basically, kind of stayed the same as far as the risk/reward trade off went. But now when we take a look on the fixed income side, investors are a little bit more risk seeking, so there was kind of a dichotomy between the two groups. Very similar for prior month for equity funds and then this month, a little bit more risk seeking on the fixed income side.


So, are you seeing these trends carry over into August?


We are. And so, I think what the concern here for me is that, how long can this rally continue considering that we saw GDP growth down 32.9% last month, or actually for the quarter? So Q2 first initial look into GDP down 32.9%, we'd never been down that far before. So, I have a little concern there. But back to your question, we saw some really strong earnings come in. So at the end of the season, we're just finishing up the earnings reporting season, our partners at Refinitiv, basically, on the proprietary research team said that about 83% of all the stocks that had reported for the S&P 500 had beat their estimates. Now, that's not the final numbers, it'll play around, but it's a high number as far as beating their expectations.

But we saw the US economy added 1.763 million new jobs, the unemployment rate went from, I told you a little bit earlier, 11.1% down to 10.2%, so we saw a better number there. And again, those earnings, I think, were kind of the telling piece of it. Now, one of the things that we're going to change, we've got the earnings in, we know what the expectations were, now we're going to be looking at the politics, we're going to be looking back at the economic numbers, and, of course, what happens with COVID-19. So yes, I expect it to continue on, but I think there's going to be a little change in pace as people take a pause because the FANG stocks had just done unbelievably well in a bad market.

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


Well, what we saw was the median discount of all closed-end funds actually came down 70 basis points, so it narrowed 70 basis points, or improved, to 8.72% for July. So, that's much better than what we've been looking at recently. But if we look at the equity funds by themselves, they widened about four basis points to 11.96%, but the fixed income funds saw the best in the narrowing situation. Fixed income funds narrowed 118 basis points dropping into 7.31%.


 How do premiums and discounts compare to their historical averages? 


They are still much wider than they were. Let me give you an example. So if we take a look at the month end at August 31, 2019, which is a year ago, the median discount was at 6.85%. Remember, this is for all funds, I'm not giving you fixed income and equities, just kind of a big ballpark view. There were 93 funds that traded at a premium for that month a year ago. Now all funds on July 31, 2020, the median discount was at 8.72%, so we're almost talking 200 basis point difference, and only 74 funds traded at a premium. So, that's quite a difference, and in the prior three months, we saw some rising, we're up in the upper nines. I do see a kind of relief here, we're back down as an 8.72%. So it is getting better and so it's better than the last prior three months, but if we go back a little bit farther, we're still far off from those discounts that we saw about a year ago.


So, which sector saw the greatest change?  


We saw the single-state municipal bond fund, those closed-end funds group, with the biggest narrowing of discounts, 204 basis points down to 8.55%. Now on the flip side, when we take a look at one of the largest increases, or widening of the discounts, we saw domestic equity funds actually see about an 88 basis point increase to 10.25%. So, still some trepidations in that area.


Tom, we are now into the second half of the year and while there are still some economic uncertainties raising concerns for investors, many are expecting stronger results as we go forward. Are there sectors where investors may find particular opportunities given where those funds are trading relative to their historical averages?


I'm going to say, yes, there are, but there's a caveat there again. The rally in the market has been so long in the tooth right now that I'm a little concerned that people are going out and just buying losers. Because we've got to be careful, sometimes the stock is down for a reason, it's down because it's losing investors, losing share or it's not doing well. But with that in mind, if we think the market is on fairly stable ground, we are seeing an improvement in employment rates. If we take a look, remember I told you, one of the bigger losers is energy master limit partnership and natural resources, well energy MLPs, I think are a little bit of problematic, there's some they're accounting rule changes that have been going on, I told you there down 58.66%. But natural resources, we do see that there's an increase in demand globally. And the use of natural resources, I shouldn't say it's always oil and natural gas, but it's a lot of oil and natural gas in there. But if we see that coming in, that's an out of favor issue that may be a buy.

We also have three other groups we can take a look at on the equity side, utility funds are down 11.15%. With the summer being in the middle and we're just kind of going into the fall months eventually here, we may start thinking that when winter comes around, utilities are going to become a useful area. They're down 11.15%, real estate is down 8.47% and preferred stock is down 8.19%. Again, these are year to date numbers I'm giving you. But I'm just trying to say from this historical trading, I think there's room there. On the flip side, if we take a look at fixed income funds, US mortgage funds, which have always been kind of an area where people would get a little bit more diversification, you maybe don't pile up a ton of money in it, they're down 8.71% year to date so far.

Loan participation funds, I don't see interest rates rising anytime soon, but they could, they're down 8.1%. And emerging market hard currency debt funds, I told you this has been a good category, they're still down some 7.57%. So, there's still some room and I think that people still should focus on quality over the next weeks and months, because that is what's going to be concerning going forward is the quality of the issues and can they withstand any slowness in the economies picking back up?

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


Well, basically when we're taking a look at interval funds, I want to make sure that we're taking a look at the different time periods, so for the year to date period that we're looking at. We basically look at the four areas that have the largest presence of interval funds in their groupings. That would mean that, for instance, real estate funds have a count of 34 interval funds in that particular classification, where there's only 10 that are not. So we have 44 funds in total in the real estate universe and 34 of them happen to be interval funds. Well, in that case, they actually outpaced their conventional closed-end fund brethren. And what I mean by that, year to date returns, 5.88% loss on the interval funds versus a 17.28% loss on the conventional fund side. And when I say conventional, I mean conventional closed-end funds.

Now, where there wasn't really a big benefit was the general bond fund category. General bond funds, they still were down about 4.96% for the year to date time period, whereas the traditional closed-end funds were only down 3%. But if I look at loan participation funds, they mitigated losses about 50% better, here we had interval funds down 5.40%, let's say, and the traditional closed-end funds were down 10.45%. And the same thing went for income and preferred stock funds as well, down about 5.28% on the interval side and 9.16% loss on the traditional closed-end fund side. And the count difference in preferred stock was nine interval funds to 27 traditional closed-end funds, bringing the count to 36. So just want to make sure we're kind of looking at the same group. Other groups have interval funds in them, but the numbers are like one to 19, so it's really hard to compare.

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


I do, and I do with a couple of caveats. Obviously, we have to remember that interval funds, of course, they have a couple of benefits, we don't have to worry about premium discounts because they're sold at NAV. But the problem with it being sold NAV is they only have refundings. And some of these refundings, most of them are quarterly, but some can be semi-annual and annual. But one of the tradeoffs that we get from this type of thing being less liquid, and, by the way, they're a little bit more expensive, but one of the things that we get there is we get access to sometimes private equity, private lending, areas that we would normally think that kind of the rich guys get, the people that are actually doing investing maybe on a more professional basis or have the higher net worth, they can get into some of these less liquid assets. Well, this is giving us that opportunity as well. So yeah, I think there's a place for this in people's portfolio, but with those caveats in mind.

CEFA:  So, how do you see these funds being best positioned in a portfolio for an income oriented investor?  


So, this is what I was referring to, it's a good diversification tool and I would look at it as that, as a sliver or a part of my portfolio rather than jumping in full feet. I think it's a great diversification tool, keep in mind they're not liquid, they are sometimes more expensive than their conventional or traditional closed-end fund brethren and they still suffer from that periodic refunding. Now with that in mind, if I am willing to make that long term investment, that long-term commitment to this fund, I'm going to possibly get higher yields out of it, I can get asset classes that I probably didn't have before, so I can get business loans and private equity, so it does add a little bit better diversification. But again, I think the bottom line is I have to understand this a long-term commitment and when I want to pull the money out, I might not be able to. Because remember I told you, those interval funds have redemptions on a quarterly basis, could be semi-annual, annual, but sometimes they only say, "We'll only redeem 5% of the assets under management," most of them say between 5% and 25% of the assets under management. But you're still not guaranteed, even over several redemption periods, to be able to pull out all your money. So again, this has to be a long-term commitment.


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

 Tom:   Thanks for having me, Diane. I appreciate it.

Audio recorded 08/11/20.


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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