I have been struck, lately, by the number of articles devoted to the beating that closed end funds have taken. The list includes Barron's, the Wall Street Journal, and countless newspaper articles that have come through my RSS feed.
I suppose the obvious way to look at it is that if so many experts say they are now cheap they will get cheaper. I'm not sure this holds up here. CEFs do have a purpose which is easy access to yield. They have their drawbacks and can be volatile but they have that yield. A well-diversified portfolio that only owns a few CEFs to capture certain parts of the market should be able to weather any down turns.
Two of my least favorite types of CEFs are ones that own preferred stocks and CEFs that own MLPs. I have written about both of these before.
An example of a CEF that owns preferred stocks is the Nuveen Quality Preferred Income Fund (JTP). The fund yields 8.3%. The 52-week high is $14.75, the 52-week low is $11.86 and it closed Monday at $13.07. The person that bought at $14.75 is down 11.3% at Monday's close. Compare that to the price range for an individual preferred I own for clients. The 52-week high is 26.60. the 52-week low is $25.13 and it closed Monday at $25.49. The person who bought at the year high and sold at the year low (the worst possible trade that could be made) lost 5.5%.
Further, the individual issue returns $25 back at maturity. The fund has no such safety net. Buying the preferred stock of a AA, or higher, rated company does not really carry unreasonable risk. I have been writing about this since the start of the site. This is an instance where the funds are actually riskier than the individual issues.
Ditto MLP funds. I have written about these several times in the past and studied the performance of some individual issues compared to a couple of funds. You can read that here and see the chart here.
I tend to think CEFs are best used in conjunction with things like treasuries, and individual preferred stocks. I use several CEFs for access to things like convertible bonds and foreign bonds. Too much of anything, no matter how conservative, can be very risky.
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3 comments:
What are your thoughts on individual MLP's. I know in June you were selling your position but I didn't see where you had a rationale.
MF
I have been looking at muni CEFs. Most of these use about 30% leverage. With short-term rates up near long-term rates, at some point the dividend payouts of these funds must suffer compared with when short-term rates were so much lower. Where do I look in the filings of these funds to try to figure out how secure the current dividend is and if it is likely to be cut, to what level? I'm happy to do my homework but I don't know what I'm looking for.
FP
Wall Street Garage Sale Produces Closed End Fund Bargains
There's a bright light at the end of the tunnel--- finally. Most of the really well respected, long term investors are advising their audiences to hang in there, to stop the panic selling, and to look for the great companies that have withstood the economic downturns of the past.
Buffet, Bogle, Gross, Schwab, and company offer sound advice--- don't run and hide, it's time to hit the Wall Street Mall and go shopping! They've seen the indicators; they've been there before. So have many of you. Clearly, it's time for action.
With IGV stock prices down 50% or more, and income securities as low or lower, Chuck Jaffe points out in MarketWatch that the case for loading up on managed Closed End Funds (CEFs) is a strong one. The great companies are in garage sale mode, and managed CEFs are selling at an additional 25% below net asset value (NAV).
Jaffe writes: "With investments, investors can only guess at how big a bargain they are getting. The one exception is CEFs, where investors looking for both bargains and income streams get a price tag that shows the actual amount of their discount--- an intriguing choice for current market conditions."
Jaffe emphasizes that investors "look inside" the wide variety of CEFs out there, and there are excellent educational websites, like ETF Connect, for hands on research. He quotes investment manager Jerry Paul, who feels that "the buying case is pretty clear", and that "the best times for closed end funds have been in crisis environments".
The CEF idea, in both equity and fixed income portfolios, boils down to this lightly edited commentary from an old friend that brainwashing book readers know as Deep Pockets: "Closed end funds are misunderstood investments and perhaps that is reflected in their volatility."
"Seems to me that the leverage on the funds would be the cause of concern, yet the taxable funds like Blackrock are not leveraged yet seem to have the same volatility as the leveraged funds. Credit risk could be another cause of concern, yet the insured municipal funds seem to be as volatile as the uninsured."
"As you have pointed out, overall income streams have been stable, yet double digit yields are all over the place. Fixed income assets are on SALE because of the decline in the bond market and thus the reduced net asset values."
"Additional opportunity exists because the Market Values of CEF stocks are at huge discounts to their already lowered NAVs. It is like the 25% markdown sale items are reduced by an additional 25% for no reason other then fear and misunderstanding."
"Looking at prior periods of panic in the markets, closed end funds historically have big rallies toward the end of bear markets. 2003 saw many closed end funds achieve returns of 25-30% in just twelve months. Those who locked in high rates during panic-selling enjoyed high income streams going forward, long after the markets turned up and current yields went down."
Deep Pockets also believes that there are flickering beacons of hope out there for a rally to commence in both markets before too much more blood is shed by the faint of heart. Here are some bright lights to focus on:
Light One: "The credit markets are beginning to thaw, with LIBOR rates coming down and commercial paper markets starting to function more normally. Some of the fear of systemic failure is abating"--- and the Fed cash infusion has not yet started.
Light Two: "Oil prices are dropping back into normal ranges, increasing the purchasing power of consumers", and reducing the costs of getting goods to market--- but hopefully not enough to discourage conservation and US development efforts.
Light Three: "The price of gold has fallen, a normal sign that fear and panic have lessened."
Light Four: "The dollar has risen to multi-year highs against many currencies increasing confidence that we will lead the global recovery"--- no matter how bad you paint the picture, there's always a recovery.
Light Five: "You just don't hear too much about inflation anymore"--- and prices just haven't fallen as they would if things were looking even worse.
Light Six: "The few up days lately on Wall Street have inspired huge volume, while the volume on down days is falling"--- remember, buyers tend to hold on for profits down the road.
Light Seven: "The 2009 P/E ratio estimates for S & P 500 companies are historically low."
Light Eight: "Dividend yields on common stocks are historically high."
Light Nine: One huge element of economic uncertainty will disappear in early November, and most would agree that this too has been discounted. Typically, the media will place more emphasis on good news during the honeymoon period.
The rally is in your hands people, let's get out there and party! How? Buy back into your 401(k) value funds, add to your personal portfolios (particularly those high yielding income CEFs), and stop taking losses on solid, mainstream, dividend-paying companies.
Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"
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