Conclusion: Closed-end fund (CEF) share price performance was spectacular for calendar year 2009. The average of the fund type averages was 40.9%; almost twice that of the S&P 500’s 23.5%. However, this increase wasn’t enough to compensate for the previous year’s decline of 43.9%. This is on top of the previous year’s decline of 9.9%. So, despite our desire to run a “victory lap”, CEFs are still 21.0% below year-end 2007.
Piling On: An additional element of concern regarding this market segment’s outlook for 2010 is the compression of the discount from 11.6% at the end of 2008 to a relatively modest discount of 4.9% at the end of 2009. This places the 2009 year-end discount above the 20 year average discount of 6.9%. So, in order for the CEF market segment to advance much depends on the underlying growth of the NAV.
Tale of Two Asset Classes: Approximately 60% of the CEF market segment is considered fixed-income. With concern over when—and not if—the Fed begins the process of tightening credit, the fixed-income fund types could “roll over” in 2010. Munis (national and single state), make up more than a third of the CEF assets, and may struggle as states face staggering deficits and systematic ratings downgrades. Ultimately, this may provide a great buying opportunity after California is driven to the brink of default on some of its municipal paper.
Signs of Erosion: In the graph below, we already see some debt fund types’ price performance erosion in the 4Qs (blue bar). NatMuniBndFnds, SingleStMuniFnds, InvGrdBndFnds and USMrtgBndFnds logged in negative performance for that period. Whether this is the top of the “slippery slope” for fixed-income we’ll have to wait for further evidence. However, based on the amount of money that has gone into bond funds over the past year it is surely a contra-indicator of future performance for the fixed-income asset class.
The Year of Equities: 2010 may be a year where investors should overweight their portfolio toward equity-oriented fund types. There is more of a viable story for equities:
- It’s unlikely we’ll have an economic relapse—albeit, not impossible;
- There are nascent signs of a global economic recovery;
- Several early market indications of an extended stock market recovery include large M&A, more IPOs coming to market and a steeping of the yield curve;
- 2010 S&P 500 earnings will likely be better than expected and provide surprisingly good comparisons.
Of course the thing that has the greatest impact on the markets will be the unforeseen event: war, terrorism, geopolitics, etc.
Recommendations: The fund types that should deserve further consideration are: GenEqFnds, ConvSecFnds and PrefStkFnds. For the sake of brevity I’ll just address the first fund type: GenEqFnds.
This fund type underperformed last year and is still supporting attractive discounts with reasonable distribution yields. Some of the large cap CEFs would be equivalent to buying a blue chip index at a discount. Those CEFs would include: Adams Express (ADX), Tri-Continental (TY) and Gabelli Dividend & Income (GDV). None of these CEFS are perfect, but from a top down analysis they may be worth a further look by investors.
Year End & 4Q ’09 CEF Fund Type Performance:
Other CEF Measurements: The follow chart compares CEF price performance for the 4Q and year-end ‘09 as measured by other major CEF data providers versus the S&P 500. The Claymore index largely excludes tax exempt CEFs and as a result posted greater gains as muni fund types were sectors that underperformed on a relative basis.
Caveats: As been noted here before, when predicting the future, predict often.
Disclosure: Author owns a diversified portfolio of CEFs including ADX, TY and GDV)