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CEF Market Review: November 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 November'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 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.


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


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


Well, it wasn't a real good month for anybody. In fact, the markets notched their worst market decline since March this past month that we're looking at. That said, the numbers aren't really all that bad if you take a look at the individuals. If I take a look at the Dow, it had the largest decline of the broad-based indices covered in the US. It was down about 4.61% for the month. And the DAX, which is the German index, was down a whopping 9.41%.

And only reason I make reference to that, is we did see developed markets not do well this month either. But really what it is, is investors were keeping an eye on all the uncertainties that are out there. Obviously, we had a pickup of new record cases of COVID-19. And again, many states were actually beating any sort of record that they set in March, so it put people back on their heels. And basically we also saw that lawmakers were not going to pass any sort of second round of stimulus package to cover the COVID-19 case, at least until after elections. And a lot of people think maybe not until the beginning of the new year.

And then of course we had what was seen as a weaker pace of job recovery. We added 661,000 new jobs in September. And keep in mind, I know everybody's saying, "Well, we're already in November," we're talking about. And we're really talking about October numbers. The September numbers were reported in October. 661,000 wasn't bad, but it was at a slower pace. The unemployment rate dropped to 7.9%.

But I think a lot of people thought that the biggest issue out there was the uncertainty around the election. And I was telling a lot of people, I really thought it was a nothingburger of a sort. People were worried about uncertainty, and markets wants certainty. But I don't know that the markets were really being driven by what was going on for the presidential election. I think that was just a side show going on. I really think it's the three main things we just talked about. COVID, basically no stimulus package, and of course, a weakening, we're getting our jobs back, but a weakening job recovery.

So we saw that equity funds, in general, basically were up for the second month in a row. And when we take a look at that, we see that they were up about 0.41% on a NAV basis, but on a market basis, I'm sorry. They were down 0.41% on a NAV basis, but they were down even more on a market basis. Down 1.98%. Now fixed-income funds on the other hand, for the seventh month in a row did post plus side returns, but only to the tune of 0.03% on a NAV basis. But we're still down, for the second month in row by the way, 0.78% for the month on a market basis.


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


Well, the equity funds, again, really did not do all that well. And again, when I say not all that well, remember the numbers I just gave you. And then when you keep in mind the Dow is down the largest as well. But if we take a look at the mixed asset closed-end fund group that we follow for the closed-end fund space, they were only down 0.08%, so they did a pretty good job of mitigating losses. The equity closed-end funds overall were down 0.35%, and the world closed-end funds group was down 0.87%. And these were all on a NAV basis. About 45% of all the equity funds in the closed-end fund space posted plus side returns. So it wasn't a 50/50, but it wasn't a complete loss as well. It did much better than the prior month.

But September, basically we had the laggard become the leader. So in October, the September laggard was emerging market and MLP funds. They were down in a big way, almost 11%, and now they were up 3.11%. Emerging market closed-end funds actually were up 1.58%. And utility funds were up 3.83%.

Now when we take a look at the bottom of the barrel, remember I told you that the DAX index did horrible, developed market funds actually took it on the chin. Not bad, but down 3.61% for October. And then they were bettered somewhat by losses through the option arbitrage option strategy group. They lost about 1.97%. So overall equity funds had a tough time, but really wasn't as bad as a lot of people thought. And despite this steepening of the treasury yield curve during the month, which we saw the long end of the curve rise quite a bit.

And I think people anticipated that we would get a $2 - $3 trillion bailout package next year. Adding that together, $6 trillion people are saying it's got to be inflationary, so we saw the yield curve and long end rise. So the fixed income macro group, did pretty well even though we saw this happening. And basically what we saw, was the fixed income macro groups, we have three that we talk about all the time. Taxable, domestic fixed income funds were able to put together about 0.32% return.

So just that little bit, world bond funds, closed-end funds were up 0.04% again. Almost nothing, but again, better than having a negative. The ones that took it on the chin were the muni bond funds. Muni bond funds were down only about 0.34%, but they experienced the only negative returns. And we think this is that issue of while equities had risk off, basically we saw that investors, even though they were plowing money into fixed income, they weren't really going after the quality issues. And that was because, again, they're expecting inflation at the long end. So we saw that.

Basically how that broke down, all nine classifications in the muni bond fund universe saw negative returns in October. But at the top of the group, if we take a look at all bond fund classifications, general bond funds were up 0.45%. High-yield closed-end funds were up 0.36%. And high-yield closed-end funds leveraged were up about 0.35%. Now if we did go again and look at the bottom, emerging markets' hard currency debt closed-end funds were down 0.72%. And then we had right close to it, Pennsylvania muni debt funds down about 0.65%.

So not a bad month at all for fixed income overall. We did see a couple of troublesome areas. And again, a lot of people were, I think, shunning quality just because of the long end of the treasury curve going up.


Is this a change in what you saw from September?


Yeah. It's a slight improvement from September, for equity funds. Remember I told you about 45% of the equity funds saw plus end returns this last month. It was not quite as good, but in the 20s for the prior month. And fixed-income was almost the same with the exception of, like I told you, munis and more higher quality debt securities were actually punished. So that was a little bit of change from September numbers.


Are you expecting these trends to carry over into November?


Well, if you had asked me on Friday, we're right now, we're recording on November 9th. I mean, this morning we heard some fantastic news. And this is really a market changer. The group Pfizer and BioNTech, basically a German firm, they came out with coronavirus vaccine candidate that's 90% effective. We've seen the markets rally like we haven't seen before. Dow was up, futures by the way, Dow Futures were up 1500 points. 5.5% just this morning.

So I think that is a game changer. Now we all have to keep in mind though, this is still a drug that's in phase three study. And so I think once the exhilaration settles down and maybe we do have something that's going to work out there. 90% effective rate for a virus, coronavirus in particular, is actually unbelievable. I think people are going to sit back and say, "We'll believe it when we see it."

So again, I think we're going to see markets continue where they were at, looking for points of continuity and consistency. And so with that in mind, I think now that the elections are over, and now that Congress can get back to work, lawmakers maybe could come back with a package. I doubt that's going to happen lame duck. But I think that people are going to be looking for this consistency that markets are begging for. And a little bit of it's already happened.

So I think we may see some improvements going forward up through December. But again, we'll probably talk about this in a few, we'll have to keep an eye on tax loss harvesting in December because I think a lot of investors have had some losses, and some big wins that they'd like to set off here in the future.

CEFA: Investors often monitor the way closed-end funds trade in relation to their net asset value. What were the trends in premium discount behavior for October?


Well, because we had some of the biggest losses that we've seen since March, I think everybody would expect that we had a general widening, and we did, for the median discount of all closed-end funds. Again, this is fixed-income and equity together, so it's a soft number. But they widened about 65 basis points, traded on October 31st. And then basically came to about 8.27% discount. Now if we take a look at the equity closed-end funds and see what the discount was there, we saw the discount widened by 50 basis points to 13.86%, which is quite large, quite wide. And then in fixed-income universe, we saw a widening as well. About 67 basis points, so a little bit steeper in the widening to 8.27% for the month.


Closed-end funds often see investors engage in tax oriented trading strategies near the end of the year. Are you seeing any tax loss selling in this space? And are you expecting much of this type of trading this year?


This is what I was making reference to just a few moments ago. I don't know that we're seeing, or that we can put any measurements by the discount of whether we're seeing tax loss harvesting at this point. Because again, we had so much uncertainty, the rise in COVID cases, and alike, I think the steepening was more of a market reaction to uncertainty and just really bad news overall with COVID-19 getting worse as it goes.

That said though, we've had a really good run-up in these last several months. And I realize that we're still under water as far as many equity closed-end funds are concerned, but I do believe that there are some big winners out there as well. And so I think there are going to be some people that pay attention to increasing their after tax returns by doing a tax loss harvesting. So yes, I think it's something we will see in December. And hopefully we'll then see that quick bounce and reverse like we generally see in January.


How do current premiums and discounts compare to their historical averages?


In the last 13 months, basically we've seen this month be the steepest discount that we've seen in at least 13 months for closed-end equity funds. And the reason I say that, is I didn't go back any more than 13 months. I usually do a 12, 13 month comparison. And so this has been one of the steepest we've seen. Let me give you an example. On 11/29/2020, basically the median discount with at 6.20% for the equity closed-end fund space. Now on 10/30/2020, we're seeing a 13.86% discount. So that's quite wide.

Now on January 31, to show it's even steeper than we said with the 6.20%, on 1/31/2020, that median discount was at 4.69% on the equity side. Now if I move though, towards fixed-income is more normal. It stayed, it wasn't quite as steep. We didn't see a doubling of the discounts. Again on 11/29, for taking a year ago time, a 6.17% median discount for fixed-income funds. And then right now, it's at 8.27%, and it's actually improving in some cases.

If you take a look at what was happening on March 3, when we all remember there was a big sell off in March, the median discount was at 9.11%. So basically, we've seen a degradation in equity closed-end fund discounts, but we've actually seen a normalization or a continuation for the fixed-income side.


And which sector saw the greatest change?


Well, we saw world income funds see the largest narrowing. Basically, it narrowed 24 basis points. It wasn't real big. 7.71% discount, but really the ones that took it on the chin and maybe in a contradiction to what I was saying a little bit earlier, that it's been a flight to safety, so to speak. But again, people have been going more towards a higher yield, getting rid of quality. What we saw though, was high-yield closed-end funds saw the largest widening of their discount. 274 basis points to 11.84%.

CEFA:  Tom, areas of the economy continue to improve, but we've had an uptake in virus cases in some parts of the country. And of course, we just had an election. With that backdrop, are there sectors where investors may find particular opportunities given where those funds are trading relative to the historical averages?


Right. Well, there is opportunity. I think we still have a lot of volatility ahead of us. Again, I told you about this big move from Pfizer and it's cohort. And I think that is going to be a game changer if in fact that turns out to be the first antiviral medication that comes out. But basically when we take a look at this, year-to-date most of the classifications are still significantly underwater. In fact, the average return year-to-date is minus 9.90%. Now people go, "Oh my gosh. How could closed-end funds be doing that bad?"

Keep in mind, energy master limited partnerships were down 60.80% for that same time period. Natural resources funds are down 40.70%. So I do believe there are opportunities to buy. Again, I think we're going to see some rotation, maybe into the health and sciences area, but certainly we keep an eye on diversified equity funds. And if diversified equity closed-end funds are more of a, I'll call it domestic equity fund group, that we may be able to invest in and get some benefit out of even some of the stay-at-home stocks. Although who knows how long that's going to last. Some of the health biotech, but basically domestic stocks, they're down 8.39% year-to-date so far.

And utility funds, if people are looking for a yield, and even though the long end of the curve is going up, we may see some benefits to utilities as well. They're down 12.17%. So that's just from the historical perspective. Looking at fixed-income funds, I would say right now, maybe quality's not the best place to be. Although people jumped in because of the increase in coronavirus and they want to go to treasuries for safe haven plays.

I think though, now, people are going to be looking more for yield again, and maybe trying to ignore the long end of the curve. Because inflation is going up. Rise in inflation will cause a rise in yields, and a rise in yields should cause an inverse relationship to price. So we might see some losses there. But basically, those might be good places to pay attention. Maybe in the middle of the curve, and maybe a little less on the quality side, so maybe out of treasuries.

CEFA:  Tom, you also follow interval funds, which typically offer a limited quarterly liquidity to investors. How have interval funds generally performed over the first 10 months of this year?


Basically we've seen... And I gave it to you before this, so let me give you a little bit of the break ups. But domestic equity funds, if we take a look at the interval funds versus their conventional closed-end fund brother, basically we're taking domestic equity funds that are down 5.22%, this is a year-to-date return by the way. And if we take a look though at the conventional closed-end fund space, they're down 18.21%. Now that said, it's a little bit of an apple to oranges comparison when they can look at the numbers. The actual numbers of domestic interval funds was only 43, while the number of conventional closed-end funds in the domestic space there is 113. So we've got to find a little bit better match.

We see real estate funds where it did a better job of mitigating losses on the interval fund side, down 4.22% year-to-date so far. While the conventional side of the closed-end fund business in the real estate classification basically was down 19.09%. So they did a better job mitigating. I can find the same case though in sector equity, where they did a poor job. So interval funds were able to produce 0.20% return year-to-date on the sector equity side. But if we take a look at the conventional fund business side, or the conventional closed-end fund side, they were up 2.01%.

So really we've had a mixture. One of the areas of interest though, is loan participation funds have done a pretty good job. They're probably the group that has the closest match. 28 interval funds to 29 conventional funds in that space. And we're basically seeing a difference in a return of 2.59% for interval funds year-to-date on the loan participation fund side, and it was a negative return. And the conventional closed-end fund space, we saw a loss of about 5.10%. So on that side, we saw a little bit better performance on the fixed-income side of the fence.

CEFA:  What type of investors do you think are best suited to utilizing interval funds in their portfolio?


I would say that it is people who are possibly looking for unique investment opportunities. On a lot of these interval funds they use the structure so they can go into a less liquid securities. So we might see some private placement equities, some private placement bonds, direct investing, a lot of people refer to that. So that's where we might be able to get a little higher return. But we have to be okay with illiquid securities, from what I was just telling you. They're going into private space. It's not going to have a lot of market turnover. So if you're looking for opportunities for a long buy and hold that might give you a better yield, this is certainly a product that people could take a look at.


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

 Tom:  Thanks, Diane. Good talking with you.

Audio recorded 11/09/20.


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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