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Lipper's March-April Closed-End Fund Market Review



Tom Roseen

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 and the Closed-End Fund Association discuss Tom’s insights on February's closed-end fund market action. 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 Merritt. Today, we are joined again by Tom Roseen, Head of Research Services with Lipper from Refinitiv and author of the Fund Market Insight Report, which provides in-depth monthly commentary on the closed-end fund market. We are happy to have you with us today, Tom.

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

CEFA: Tom, you recently published your report covering March 2020. You study over 500 closed-end and interval funds regarding performance, premiums, and discounts and corporate activity. Since we spoke last month, we have continued to see significant market volatility. What has been the general impact on closed-end funds, and has there been any dislocation between activity among closed-end funds and what is occurring in the broader market?

Tom:

Well, actually, whether we were in closed-end funds, open-end funds, individual securities, it was a gut wrenching month to be in the market. This was the perfect storm that was being created over the month. I mean, not only did we have horrible news around COVID-19 playing havoc in the world's citizenry, but we also had skyrocketing infections. We had increase in death rates, and then the shelter-in-place orders that came out in the United States, which really had a huge impact on global commerce and put all the markets at significant edge. And with this, we had piled onto this argument between Saudi Arabia, let's call it OPEC and Russia, where they reduced their... They were talking about trying to reduce oil output, right? And they got into this horrible price war. During the month, we saw 54.24% decline in oil prices to $20.48 cents per barrel. That, we haven't seen for at least 18 years, such low numbers.

And then the top of that off, we also saw the Fed cut its rate to zero. Now, that normally would be a good sign, right? It means that the Fed is injecting money, they're doing some things to make sure that the liquidity enters the market. However, what happened with that is people, all of a sudden, because of this decline and the disruption in the global commerce community, they basically saw an increase in credit quality spreads. So, now investors started becoming very concerned on whether even high-quality companies will be able to make payments on their interest payments, whether municipalities locally will be able to do the same, and this played havoc in the market.

So, let me give you an example, equity closed-end funds declined 20.64% for March. That is the largest one-month nav-based decline that we have seen since October 31st, 2008. And to make things even worse, we saw a 25.84% decline in the market-based prices of closed-end funds, and that was the worst we've seen in at least 35 years. Then if we take a quick look at the fixed income side of the arena, we see that the one month nav returns actually declined 12.8%. By the way, that was the worst in 35 years. And then if we look at the market prices, they saw a 14% decline. We did see that in September 30th, 2008, we had a similar decline, actually a little bit steeper. So, we really have entered uncharted territory for a couple of these areas that we're looking at in the closed-end fund arena.

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

Tom: So, this is one of those things where we talk about mitigating losses. Mixed asset funds lost about 17.81%. This is in a month, by the way. World equity funds were down 18.10%, and domestic equity funds got trounced down 22.21%. But really, we did see a couple of areas that mitigated losses better. Income-oriented groups, real estate closed-end funds were only down, tongue and cheek, 10.79%. Option strategy, option arbitrage funds were down 11.62%, but where we saw the real hurt was energy MLP funds down 63.74%, natural resources funds down 38.59%, and even utility funds down 18.79%. And then if we look on the fixed income side, we see that municipal bond funds did a better job of mitigating losses, only down 8.24%. domestic taxable bond funds were down 15.84%, and world income was down about 17.69%, and they were really clobbered by... Remember, I said people are really concerned about the credit quality. Will people be able to pay the interest due on the paper that they've sold?


So, the firms that are out there, so emerging market debt was down 20.45%. High yield leveraged funds lost 17.23%, but on the municipal bond fund side, we saw intermediate muni debt funds only down 5.02% and the general and insured muni bond funds down only down 5.88%. And again, I don't think I would have ever imagined a couple of months ago saying, "Only down 5.88%" when I'm talking about a muni bond fund. But again, we've entered this kind of new realm of the perfect storm just playing havoc on the complete market.

CEFA: Is this a change in what you saw from February?

Tom: It is. So, it's kind of the same order and magnitude of losses that we saw. Remember last month that we had talked about energy MLP and natural resources funds taking it on the chin, but the magnitude was much different on the equity side. And one of the things that we saw and that we're concerned about is that this was not only a drop in, let's say, what you and I've experienced as investors, but it really was a drop in total net assets. So, we have some concerns on whether the fund families are going to have to cut distributions, whether they're going to be able to meet their leverage tests or asset coverage tests that they have to meet in order to do leverage. And so I think this is kind of the change, but it is similar.


Now, we get on the fixed income side, we're kind of a new ball game again. Up for the last four months, I've been telling you that the municipal bond funds that have been the place to be. Four positive months of plus side performance, all the categories, all the classifications were in plus side returns. Well, this month, all of them are in negative territory. So, really, people are even concerned about some of the quality issues on the taxable fixed income and tax exempt income side.

CEFA: Are you seeing these trends carry over into April?

Tom: We are. I think there's maybe some positive news. I mean, the market has rallied 11% in the last two days, so we're up today at least... Market's not quite closed quite yet, but market was up almost 7% yesterday. So, we may be seeing a bottom to this, but I think we have to be very cautious about it. But again, I think one of the things that we're going to have to keep an eye on is the leverage and distributions. Are those going to change? But again, we may have turned the corner, but we'll have to see.
 
CEFA: Now, closed-end funds can trade at a premium or discount to net asset value. What were the trends in premium discount behavior?

Tom: We saw that all funds... Overall, if we're looking at all closed-end funds, we saw all widening of their median discount, 170 basis points to 9.78%. If we take a look at the individuals, equity funds got clobbered worse, as we would imagine with the market doing the big tank that we saw, 311 basis points to a median discount of 10.84% and then the fixed income group saw about 73 basis points in widening of their median discount to 9.11%.

CEFA: How do premiums and discounts compare to their historical averages?

Tom: So, this is where I think people will sit up and pay a little bit more attention. If we go back two months ago in January, we saw that, overall, median discounts for all funds was about 4.95%. That has increased to 9.78%, so almost a doubling. In equity funds, we saw it double. And on January 31st, the median discount was about 5.4% for the median for the equity funds. That is now at 10.84%. And for fixed income, overall, we saw 4.96% on January 31st, and now we're at 9.11%. Really, kind of the telltale was the number of funds trading at a premium on January 31st was 115. We're now down to 60, so that has certainly almost halved as well.

CEFA: Which sector saw the greatest change?
 
Tom:  National municipals actually saw a narrowing of discounts. And again, this is where people are looking and saying, "Listen, there's some quality there." Some of these horrible returns were throwing the baby out with the bath water, and I think that was seen in some of the national munis. So, we saw a narrowing of discounts, about 87 basis points to about 6.52%, but world income funds, as I told you, emerging market debt and the like took it on the chin. We saw a widening of about 358 basis points to 10.26% for world income funds.

CEFA:  Tom, with this degree of market volatility, are there sectors where investors may find particular opportunities given where those funds are trading relative to their historical averages?

Tom:  I believe there is, but I say that with a lot of caution because I don't know and I don't think anybody knows. I mean, if you look at one pundit out there, they're saying we've turned the corner. You know, things have gotten better in New York, the contagion rate is not as high as it was and death rate is starting to calm down, so maybe we've turned the corner there. But you go to the next analyst out there and they're saying kind of just the opposite, that there's more shoes to drop. So, I cautiously say, for instance, we know that the folks that make the next breakthrough, health and biotechnology funds may be something that people could keep an eye on. But one thing I'd like to caution is, as we are taking a look at it, and the closed-end funds are based on yield, we do have to look at whether they're using leverage, whether they are going to violate their asset coverage test for leverage.


I think people remember that if you use debt, you have to have 300% as a coverage test, meaning that for every dollar that you borrow in debt, you have to have $3 in assets. And with the big decline in total net assets, right, because of these huge declines, we have to see if funds, closed-end funds, are going to have to cut their distribution because they violated the assets coverage test. And in addition, there are the two areas that I think I'm most concerned with that I wouldn't look for deals here yet until the dust settles, and that's energy MLP funds. We've had some energy MLP, two of them, that had over 80% losses. And in fact, the highest was 87.34% loss due to this market decline, and I think we need to keep an eye on that. And also natural resources funds, they had a tough road to hoe as well on this one.


And so I'd be cautious pulling the trigger too quickly. But yes, I think there are going to be some classifications out there where they have good quality, like some of the option arbitrage option strategy funds where they're doing covered calls and the like where they're buying high-quality, getting high distributions, but we still have to watch for, again, two things. Are they going to cut the distribution? And then the last piece, do they have leverage and are they going to have to cut leverage or reduce leverage? And that may cost them significant dollars and then some pain as far as returns go.
 
CEFA:  Tom, you also follow interval funds, and we have been speaking over the past several months about how they differ from traditional closed-end funds. How has the market volatility impacted interval funds?
 
Tom:  So, we have talked about this and the fact that they don't have to worry about premium and discounts, right? Because obviously, they only sell at NAV and they basically can be purchased at anytime during the month, but they only have quarterly refunding. Usually, it's quarterly refunding. And when they do have to sell, they only have to sell between... Usually, it all depends what it is in their prospectus and their annual reports where they're stating between 5% and 25% and it's at the discretion of the manager. So, there are some benefits that I think that we take a look at that they don't really have to worry about mass redemptions as we do with traditional open-end funds. But again, if they have any sort of leverage, and I don't believe they're doing preferred. I believe if they are, they're probably using debt. They may have to sell into that, into the debt issue. But again, I think there's a positive there. We're basically having investors safe from themselves, if you will, because there is no selling pressure, at least not immediately.
 
CEFA:  Interval funds often make investments in private securities. Does this create any challenges in the current market environment?
 
Tom: It does. And so this is kind of what I was referring to. Remember, I told you about high yield and loan participation funds and even emerging market debt. One of the things that they do... Their job is investing in illiquid security stuff that really cannot be redeemed. And if they're forced to redeem, they may have to sell into this market that caused the 87% declines I was talking about in energy MLP, because if you have to get rid of it because you have to meet certain requirements, it could cause some hardship in trying to sell. It's very hard to get a fair market value for assets that are being discounted and illiquid assets that really nobody wants to buy at this time. So, I see that as a little bit of a disadvantage at this time with the illiquid securities.
 
CEFA:  Is it possible that less liquid investments could also present interesting opportunities in markets such as these?
 
Tom:  Absolutely, and this is one of the benefits. So, if they don't have to sell into this market turmoil and they have the higher returns coming out that usually you get with an illiquid security, that's why people buy them. They usually have a higher yield. There is a possibility that, two things, I could be saving myself from selling when I should be buying. A lot of people will unfortunately buy high and sell low, right? And in interval funds, I'm being saved from that, but also, I can also get some higher yields out of it. So, I think this will be an interesting test case that we'll probably look back upon to see how the interval funds actually behaved and how well they fared during these troubling times.
 
CEFA:  Tom, thank you so much for taking the time to join us today.
 
Tom:  Thank you, Diane. Good to be here again.
 
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 04/09/20.



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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