Closed-End Funds from Mutual Fund Managers

expatsp

Ed's comments this month resparked an old thought of mine, that CEFs' structure has a couple big advantages over open-ended mutual funds: the manager doesn't have to sell holdings to meet redemptions when investors panic in a downturn; and if you are both clever and brave, you can buy the CEF at a big discount to NAV during panic-driven downturns.

I thought it be good to put together a list of good CEFs, ideally run by managers who are successfully implementing a similar or identical strategy in an open-ended mutual fund, to consider buying during the next correction. Anyone out there have some favorites?

Ted put a couple links in another thread, are they're a great place to start, but I'm curious if anyone out there has already done more research.

My ideas include the ever-popular PDI, TEI (Hasenstab's EM bond fund), and maybe the Royce small cap CEFs: RMT and RVT.

And if anyone wants to tell me some of CEFs' disadvantages, I'm all ears!

Ted

@expatsp: I wouldn't get carried away with the premium/discount aspect of CEF's, when you buy a sell a CEF, your paying market price not NAV. Buying shares of a closed-end fund just when they’re offered through an initial public offering (IPO) comes with big risks. That’s because the fund’s discount or gap between share price and NAV typically widens in the months following an IPO
Regards,
Ted

Vert

Everything that I've read says that you shouldn't buy CEFs at the initial public offering for the reason Ted gave, but after that they usually will trade at a discount and the manager is given a freer hand. Some other possibilities:

Hasenstab also runs a closed end world bond fund, GIM, which is mostly emerging markets now. EMF is an emerging markets stock fund from Templeton.

SOR is run by the same FPA managers who run FPPFX. I think it's pretty much a clone.

DoubleLine has a couple of closed end bond funds: DSL and DBL. Legg Mason also runs a world bond fund, BWG, that is much like its open end world fund.

AKAFlack

expatsp –

A few high yield CEFs…
ETY, NCZ, PTY

Many CEFs have relatively high expense ratios.
However, more important is the Spread – the annual dividend
yield minus the ER.

For example –
ETY’s spread is 7.72%
PTY’s spread is 7.90%
NCZ’s spread is 9.84%

A few Equity CEFs -
UTF, ETV, CSO

A few Debt CEFs -
EVN, EVV, DSU, HIO

For what it’s worth.

Oh, and you want a CEF that trades >100K daily. All of the above do.

msf

There are lots of gotchas with closed end funds. For example, the "spread" may be due to the fund being a managed payout fund that is eating away at your principal.

Managed distribution funds attempt to pay the same amount in dividends monthly (or quarterly or whatever). If they are making at least that much money, wonderful. But if not, they're paying that high dividend rate out of principal - you're getting your own money back, not earnings.

ETY is an example of this. According to its latest semi-annual report, "the Fund makes monthly cash distributions to common shareholders, stated in terms of a fixed amount per common share. The Fund currently distributes monthly cash distributions equal to $0.0843 per share."

That's regardless of whether the fund is even making money at all. M* reports that YTD, out of $0.843/share in total dividends (i.e. 10 months worth), $0.5281/share was your own money back (returned capital), not earnings. That comes out to be around 5% per year of dividend not being income. The true "spread" is thus closer to 3% than to 8%.

M* writes of this fund: "This fund, among others in the series, has used destructive return of capital extensively in the past to meet its distribution targets. ... data for calendar-year 2013 thus far indicates the fund may again use destructive return of capital to a limited degree. That's one reason the fund earns a Morningstar Analyst Rating of Neutral."

Leverage is another factor in a lot of closed end funds. Not this one, and I'll leave that for another post, or for others to comment on.

Make sure you understand how CEFs work - how they're traded, what affects their price, how their dividends work, how they raise money if leveraged, etc.

expatsp

Thanks all your thoughts. Yes, I wasn't thinking of buying at an IPO, my idea was to wait for a correction, when besides NAVs dropping, many CEFs also see their discounts increase to greater than historic level, so if you're brave you can buy both the underlying portfolio and the overall CEF at a good price -- kind of doubling down on betting against Mr. Market. It's the theory that the fund RNCOX uses and I'm thinking of trying it on my own with highly liquid CEFs that have good management teams.

The Doubleline CEFs look interesting.

BenWP

You could subscribe to Tom Herzfeld's CEF advisory newsletter (http://www.herzfeld.com). It's expensive, but it does recommend specific CEFs whose discounts you may exploit.

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David_Snowball

The folks who once ran Third Avenue Focused Credit (TFCVX) left to run the closed-end Avenue Income Credit Strategy (ACP) which launched in January 2011 and earns five stars. Eighteen months later they launched Avenue Credit Strategies (ACSAX), which has $2.2 billion but no M* rating yet. If you overlap the charts, you get a clear sense of leverage in the CEF version but no real gain in total returns from the effort.

David

Vert

CEFs are sometimes vehicles for tax loss selling at the end of the year, so the possibility of buying bargains can open up.

franktrdr

Expatsp,

You might want to check out this ETF, if you don't know about it: YYY.

http://yieldshares.com/yyyetf.aspx
"The YieldShares High Income ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the ISE High Income™ Index. The Index is comprised of 30 closed-end funds (CEFs) ranked highest overall by the ISE in three criteria: fund yield, discount to net asset value and liquidity."

There's also an ETN that tracks the same index and uses 2X leverage: CEFL
http://etracs.ubs.com/product/detail/index/ussymbol/CEFL

I've had success trading CEFL, but I consider it high risk.

fundalarm

permanent capital that CEFs raise is extremely helpful in less liquid situations and is being exploited in fixed income funds investing in high yield, non-agency mortgages, munis, loans, cat bonds, EMD, distressed debt, private placements, etc. these fixed income funds represent majority of the CEF universe and don't practice managed distribution.

managed distribution is almost unique to equity CEFs. honestly, i don't think that anyone who is buying a large cap portfolio of AAPL and such and gets 8% annual distribution doesn't understand that at some point they are getting their capital back. i generally don't understand why you need to access equities via CEFs anyway... so managed distributions is not a concern for majority of the CEF investors.

with respect to CEFL and other gimmicky leveraged packages of the CEFs, i advise against. Most CEFs are levered, you don't want to pile leverage on top of leverage...

to add to the OP discussion, AWF has an open end sibling. Ivy's IVH strategy has a successful long-term history as a OEF. (both did change their management team fairly recently.) private equity firms are piling in with the CEF offerings as well (Apollo's AIF is one example.)

FA

Maurice said:

Managed distribution funds attempt to pay the same amount in dividends monthly (or quarterly or whatever). If they are making at least that much money, wonderful. But if not, they're paying that high dividend rate out of principal - you're getting your own money back, not earnings.

msf, you are quite correct. But when this fact is put to many fans of high yield CEF's, they don't seem to care. They just talk about the yield, and turn a blind eye toward the concept of total return.

rjb112

My understanding of the ipo issue with CEFs: There are costs to bring a new closed end fund to the market. Those costs are borne by those who purchase the initial public offering. When I looked into it years ago, those costs averaged approx. 5%. So at the time, most closed end funds, at the ipo prior to the first trading day, were priced roughly 5% above the NAV, due to those costs.

msf

fundalarm said:

managed distribution is almost unique to equity CEFs. ... i generally don't understand why you need to access equities via CEFs anyway... so managed distributions is not a concern for majority of the CEF investors.

Still true, but not as obvious as one might think. From ICI's 2014 Investment Company Fact Book:

Historically, bond funds have accounted for a large share of assets in closed-end funds. A decade ago, 75 percent of all closed-end fund assets were held in bond funds, and the remaining 25 percent were held in equity funds (Figure 4.2). At year-end 2013, assets in bond closed-end funds were $165 billion, or 59 percent of closed-end fund assets. Equity closed-end fund assets totaled $114 billion, or 41 percent of closed-end fund assets. These relative shares have shifted, in part because cumulative net issuance of equity closed-end fund shares has exceeded that of bond fund shares over the past seven years. In addition, total returns on U.S. stocks* averaged 8.1 percent annually from year-end 2003 to year-end 2013, while total returns on bonds† averaged 4.7 percent annually.

CEFconnect reports only 6 out of 146 closed end taxable bond funds (and no tax-free bond funds) have managed distributions, confirming that most managed distribution funds are equity funds.

expatsp

Thanks for your thoughts, all. @fundalarm AWF looks particularly interesting for after a high yield correction. And I'm continuing to watch TEI.

fundalarm

it's still a regular IPO process with 5% underwriting fee and over-allotment shares (support). It takes around 45 days to get rid of the premium most of the time. under certain market conditions and in several "star" offerings, premium might only increase over and above 5%, but it is indeed a rare occasion.

underwriting fees are paid by investors who get access via financial advisors associated with the underwriting, most notably UBS, MS, BAC.

for a semi-educated investor, the time to buy after the IPO premium has disappeared. it could be due to the price going down or due to exceptional performance of the NAV catching up with the price.

rjb112 said:

My understanding of the ipo issue with CEFs: There are costs to bring a new closed end fund to the market. Those costs are borne by those who purchase the initial public offering. When I looked into it years ago, those costs averaged approx. 5%. So at the time, most closed end funds, at the ipo prior to the first trading day, were priced roughly 5% above the NAV, due to those costs.