CEFs Reverse Course: Risk Avoidance Tops the Week

The 13 closed end fund (CEF) types on average declined 2.5% the week ending 5/15/09 versus a decline of 4.6% for the S&P 500 as measured by the SPDR S&P 500 ETF (SPY). On an aggregate, unweighted basis, the weekly price decline for 641 CEFs was 2.1% for price data available. The Claymore CEF Index registered a slightly greater decline of 3.6% for the week. The Eqcome CEF Fear Index increased: prices declined 1.4% more than their related NAVs for the week. This is consistent with a 3.3% rise in the CBOE Volatility Index (VIX) which rises when the market declines.

Increased market uncertainty, a result of a series of suspect economic numbers, skewed relative performance to favor the non-equity CEF fund types. National muni bond funds eked out a fractional gain, while other debt fund types racked up losses to a lesser extent than their equity-oriented cousins.

For sake of weekly comparison, both the performance of the S&P 500 and the VIX demonstrated a punk overall performance for equities. With regards to the debt segment of the markets, Vanguard Total Bond (BND), iShares Muni fund (MUB) and iShares mortgage backed securities fund (MBB) registered modest gains, 0.6%, 0.5% and up 0.6%, respectively. Gold (GLD) advanced 1.7%, while oil, as measure by the US Oil ETF (USO), fell by 3.7% on renewed concerns of economic global growth sans China.

Commercial real estate, as measured by Vanguard Real Estate Investment Trust ETF (VNQ), plunged 11.3% after several weeks of “short squeezing”. Consensus that commercial real estate is the new “ground zero” for banks added fuel to the precipitous decline. Much of commercial real estate turmoil will be in the private real estate markets; public entities have already experienced significant price declines and have been fortified with new capital. (This is going to be a good sector to trade over the next 6 months and investors should consider trading the ProShares Ultra Real Estate (URE).)

For the sake of data points, Van Kampen Municipal Trust (VKQ) was one of the better CEF performers for the week, up 4.1%. One of this week’s bigger losers was in the real estate sector: Neuberger Berman Real Estate Securities Income Fund Inc. (NRO) was down 21.9%.

Focus CEF: The focus stock for the week continues to be Boulder Growth & Income Fund Inc. (BIF), off 3.3% last week. There continues to be consistent, significant insider buying in May with another $1.3 million accumulated so far this month. This brings the total ownership by the Ernest Horejsi Trust No 1B (considered a “control person”) to 17.9% of BIF. Berkshire Hathaway “A” (BRK.A) & “B” (BRK.B) shares comprised 24.6% of BIF’s portfolio and close to 30% on an equity basis. With the BIF selling at 22.2% discount to NAV, investors are buying Warren Buffett at a discount. (Now, would he be proud of us!) While BIF’s board suspended its distribution late last year—some contend to facilitate the acquisition of shares by insiders at distressed levels—it’s expected that distributions will likely be reinstated in this calendar year.

Disclosure: Long GLD, USO, VKQ, NRO, SPY and BIF.

Comments

[User 415504:]

While I'd like to see dividends reinstated, I wonder why the author thinks it is likely by the end of this year.

May 17 08:24 PM

[Joe Eqcome:]

User 415504

There are several reasons why a CEF, which is legally required to distribute annually its earnings and realized capital gains, would not:

1. It has no earnings and profits (E&P);
2. It utilizes its loss carry forwards to off-set earnings and profits;
3. It is precluded from distribution due to a leverage ratio that exceeds regulatory requirements.

A rising stock market has several of the elements that would enable BIF to reinstate its distribution.

In the last 5 fiscal years, BIF has generated investment income. In FY ’08 it did recognized capital losses. BIF’s accumulated net losses are minimal, so any earnings would be likely to be subject to distribution. (While I’m not an accountant and recognize I’m on “thin ice” here, in theory, management could continue to absorb earnings by selectively recognizing losses and therefore postpone distributions.)

To the extent that distributions are a function of regulatory restrictions, rising stock markets and alternative financing of ARPS would mitigate that hurtle.

Lastly, there are those that suspect that the distribution reduction was a ruse to allow the insiders to accumulate their positions at vastly reduced share prices. And that management of BIF would reinstate the dividend to enhance the value of their shareholdings as well as generate incremental return on investment.

While I can not provide a smoking gun with regards to specific legal requirement for such distributions by calendar year end, I believe there’s enough circumstantial evidence for its reinstatement. Loosely translated, I’m speculating on a distribution reinstatement.

Joe Eqcome

May 18 09:48 AM

[Dan Plettner:]

Aggressive Level Rate Distributions have been utilized effectively by this group as a tool in the past. BIF has tremendous flexibility and resources; I believe Joe's thesis has merit.

Be meticulous in assessing what (and whose) purpose their distribution tools serve. The non-insider shareholders' short term interests are aligned with insiders' short term interests while management seeks to create the condition (trading premium) under which a rights offering can be conducted (for insider interests).

The tactics and strategies conducted by Horejsi affiliated closed-end funds are artistically intelligent, regardless of ethic or legal concerns. I have written ten articles on SeekingAlpha; each pertains to Horejsi and closed-end funds he affects.


On May 17 08:24 PM User 415504 wrote:

> While I'd like to see dividends reinstated, I wonder why the author
> thinks it is likely by the end of this year.

May 18 10:32 AM

[bsharvy:]

A CEF isn't legally required to make distributions; if it is willing to pay taxes, it can keep and reinvest the income.

The problem with BIF and BTF is that the fees are high. You are paying over 2% a year for the ability to own Berkshire in small amounts.

May 18 12:50 PM

[Joe Eqcome:]

bsharvy

Yes, you're technically correct, but I believe there is a limited number of circumstances where it would be justified. No one buys a conduit like a CEF so its management can retain earnings minus taxes to be reinvested. There are operating companies for that purpose which have greater flexibility of operation.

Joe Eqcome

On May 18 12:50 PM bsharvy wrote:

> A CEF isn't legally required to make distributions; if it is willing
> to pay taxes, it can keep and reinvest the income.
>
> The problem with BIF and BTF is that the fees are high. You are paying
> over 2% a year for the ability to own Berkshire in small amounts.

May 18 01:17 PM

[Joe Eqcome:]

bsharvy

As it relates to owning Berkshire through BIF--which represents 30% of the equity holdings, even if you valued the other 70% of its portfolio at par, you would have a 3.3 year breakeven at a 2% annual management fee before the current discount was consumed by the cumulative fee. (22% discount/((2% fee/30% Berkshire portfolio holdings)). Since Warren Buffett is a full professor in the investment business, I'd be willing to give him the courtesy of waiting at least 12 months prior to bailing.

Joe Eqcome


On May 18 12:50 PM bsharvy wrote:

> A CEF isn't legally required to make distributions; if it is willing
> to pay taxes, it can keep and reinvest the income.
>
> The problem with BIF and BTF is that the fees are high. You are paying
> over 2% a year for the ability to own Berkshire in small amounts.

May 18 03:00 PM