CEF Q4 2012 Review/2013 Outlook: Dividend Cuts, Solid IPO Results And Discounts Resurfaced

by: John Cole Scott

On Tuesday, January 8, 2013, Closed-End Fund Advisors held its review for the previous quarter as well as its outlook for closed-end funds in 2013. The session was recorded and has been archived on our website and blog for replay. The slides are also available for download (in PDF format).

During the quarter, we lost 10 closed-end funds on a net basis. We ended the quarter with 219 equity CEFs and 377 bond CEFs. Discounts widened during the quarter to an average of -3.18% on December 28, 2012. We tracked this trend as it developed in our Universe data service. The key issue for the quarter included:

  • Bond fund and Specialty Equity fund discounts widening to levels last seen in mid-2012

  • Significant dividend cuts in many sectors, especially the Muni Bond grouping

  • UNII Trend continued down for Municipal funds but Taxable Bond funds saw an increasing trend.

  • Earnings coverage increased during the quarter, but it was primarily caused by dividend reductions vs. earnings increases.

  • A continued high rate of mergers primarily for State-Specific Municipal Bond CEFs

  • Return of capital trended down for MLP funds, but increased for Energy and Utilities funds

  • The CEF IPO market continued on a very healthy level; 2012 funds fared much better in the secondary market vs. the 2011 vintage CEF IPOs.

Dividend levels continue to be a significant factor for closed-end fund investors. As we expect to have significant distribution reductions in 2013 for both equity and bond CEFs, we track various data points to anticipate the changes that board of directors or trustees will need to undertake.

Relative Undistributed Net Investment Income (UNII) looks at the level of UNII reported by the fund as a percentage of the annualized income-only dividend. We have found that it is more important to track the direction of UNII vs. simply the level for funds as they age from their IPO date. We also track the trend and percentage of a CEF's dividend that is classified as return of capital (RoC).

Dividend changes occurred in all five major peer groups; however, dividend cuts were the most dramatic and widespread for Municipal funds. This was followed by Taxable Bond funds and Non-US Equity funds. The only dividend increases for Municipal Bond CEFs were in the Build America Bond grouping. Increases were also prevalent in the Specialty Equity and Taxable Bond groupings.

While we never prefer a dividend cut to an increase, we like when board of directors make small changes (5%) to a fund's distribution policy when earnings and dividend expectations need to be adjusted. Investors react far more favorably to this change vs. 10%+ reductions. While we like increases, when boards make large increases it tells us they might also make large cuts at some point in the future.

Market Price and NAV Performance for the Quarter:

2012 ended well for all closed-end funds, the average fund posted a +13.7% return. However, bond and US equity funds came under pressure during the 4th quarter. Non US equity funds continued their rally, finishing the year with just over a +20% return. We don't expect as robust returns for bond CEFs in 2013, and therefore feel more comfortable now that CEFs are closer to their 10-year average discount of -3.8%.

Activist update (Courtesy AST Fund Solutions / www.CEFInsight.com). Activists focused on deep discount, lower yielding CEFs.

Closed-end fund deaths remained low in 2012 with just one more death than in 2011 when we lost 5 CEFs. 57 mergers occurred in 2012 more than three times the previous highest level in 2009 when we lost 18 funds. The highest activity was in the state specific municipal bond grouping.

Closed-End Fund 2012 IPO Trends:

2012 was another year with a very healthy flow of IPOs for CEFs. The welcomed change was that 7 out of 16 (44%) CEFs traded above NAV after 90 days at the end of 2012. CEFA uses 90 days from inception as the time when a fund is past underwriting support and investors start to buy and sell the fund based on true market forces. Market forces become even more pronounced once the fund releases its first semi-annual report after six months.

Closed-End Fund Correlation Trends:

We continue to track the correlation between an individual CEF's market price and its NAV over time. As it has only been about six months since we started tracking this data point, the trends are just now starting to form. Because of investors' pursuit for yield in a yield starved environment, closed-end bond and specialty equity funds exhibited the largest dislocation from their NAV movements with the lowest correlation and correlation trend vs. US and Non US Equity funds, which are less yield oriented as a group.


We recommend that investors remain cautious of funds both at premiums to net asset value as well as near the top of their discount/premium ranges. Just because a fund has traded at a high premium or has "never cut its dividend" does not mean that you can't suffer potential losses when the rules or markets change. We advocate reviewing updates from fund sponsors on at least a quarterly basis, though many funds update fact sheets monthly.

We continue to believe NAV performance is a critical figure to monitor because in the long term, the fund's market price is anchored by this figure. If a manager cannot produce above average return for shareholders, it begs the question for active management.

Discounts from NAV or relative discounts vs. the fund's historical levels continue to offer investors some protection from market volatility and drawdowns and we encourage investors to monitor this information on their current holdings and consider making changes in their selections as potentially better options become available.

You can download the slides or watch the replay from the presentation here: [Slides] [Replay]

The replay file is quite large and recommend using the most recent version of your web browser or try different browsers. If you use a Mac then you will need to install the Windows Media File plug-in. It may take a few minutes for the presentation file to load inside your web browser.

CEFA's Data Definitions can be found here.

Disclaimer: The information and statistical data contained herein have been obtained from sources that Closed-End Fund Advisors (CEFA) believes are reliable, but CEFA makes no representation or warranty as to the accuracy or completeness of any such information or data and expressly disclaims any and all liability relating to or resulting from your use of these materials. The information and data contained herein are current only as of the date(s) indicated, and CEFA has no intention, obligation, or duty to update these materials after such date(s). These materials do not constitute an offer to sell or the solicitation of an offer to buy any securities. CEFA may make decisions for its clients in certain of these securities. CEFA and/or their respective officers, employees, and affiliates may at any time hold positions in any of these securities and may from time-to-time purchase or sell such securities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.