2013 has been a subpar year for most equity CEFs, both in Net Asset Value (NAV) performance and market price performance. It's not so much that it's been a bad year per se, it's just that most equity CEFs have not been able to keep up with the soaring broader market averages.
Obviously, it's been an incredible year for the broader market averages with the S&P 500 up 24.1% YTD through November 8th, the NASDAQ up 29.8% and the Dow Jones Industrial Average up 20.3%. The small cap indices are up even more though overseas markets haven't been as strong as the U.S. markets, particularly some Asian emerging markets.
Equity based CEFs have generally lagged the major market U.S. indices for a few reasons that I will outline later but I want to first show you a table below which lists the top 30 equity based CEFs by their total return NAV performance (i.e. distributions added back but not on a re-invested basis). Green in the Total Return NAV column means the fund's NAV has outperformed the S&P 500, as reflected by the SPDR S&P 500 ETF (SPY), which includes dividends, and red means it has underperformed. Purple is for funds which use a specialized income strategy, orange is for a leveraged income strategy, light blue is for an option-income strategy and olive is for funds which primarily use a dividend-harvest strategy.
Note: Only the top 30 funds out of about 100 equity based CEFs I follow are able to be shown. Total return performances are through November 8th.
As you can see, only a handful of equity based CEF NAV's have been able to outperform SPY, currently up 26.2% with dividends, and they are either pure stock based leveraged funds, mostly from Gabelli (GBL) or specialized funds such as the H&Q Life Sciences Investors fund (HQL) and the H&Q Healthcare Investors fund (HQH), which include both public and private equity investments in healthcare and biotechnology.
Though one would think more leveraged funds (orange) would be able to outperform the S&P 500 since leverage can turbo boost fund performance, CEF investors need to realize that most leveraged equity based CEFs include anywhere from 10% to 50% of their portfolios in fixed-income securities, such as high yield corporate bonds, preferreds, etc. Fixed-income securities serve to leverage up income as well as lower volatility in leveraged equity CEFs, though in a year like 2013, higher interest rates has mostly hurt these fund's fixed-income investments and performances.
The option-income funds (light blue) typically do not include ANY fixed-income in their portfolios but they have still lagged since their covered-call income strategy is defensive in nature and their NAVs will not capture the amount of upside that we have seen this year. Anytime the markets are up more than 15% or so in a year, most option-income funds will find it difficult to keep pace and the higher the option coverage on a fund's portfolio, the more the fund's NAV will lag. However, a couple option-income funds, like the Nuveen Core Equity Alpha fund (JCE) and the Nuveen Dow 30 Enhanced Premium fund (DPO) have been able to keep pace and have even outperformed their benchmarks because they include either leverage or they include long S&P futures to juice total returns.
And finally, many equity based CEFs have lagged because they include foreign stocks or fixed-income in their portfolios and foreign markets have generally not performed as well as the U.S. markets dependent on which popular international ETF index you use. The iShares MSCI EAFE index (EFA), the most heavily traded and broadest based international market ETF, is up 16.7% YTD on a total return basis through November 8th, though the more SE Asia focused ETF (minus Japan) iShares MSCI Pacific fund (EPP), is up only 7.1% YTD.
NAV Performance vs. Market Price Performance
Everything I have said above relates to a fund's NAV performance, which is the true performance of a CEF compared to its benchmark. But as most investors know, a CEFs market price performance can actually be better or worse than its NAV performance and if I sort the table above by the Total Return Market Price Performance, a few more funds creep into the green camp outperforming SPY, but not many.
In fact, it has gotten so lopsided with so many ETFs, like SPY, outperforming the vast majority of CEFs this year, that I have been forced to rebalance portfolios more into ETFs than CEFs since that is where the performance has been. Again, it's not so much that CEFs have done poorly this year, it's just that as long as the Federal Reserve continues to provide liquidity to power the equity markets higher, ETFs will be more of the direct beneficiaries than CEFs. But that doesn't mean there aren't excellent opportunities in equity CEFs right now and as I pointed out above, a CEF's market price is not bound by its NAV and can provide alpha and outperform the broader markets going forward with the right catalysts. Here are a few such funds and one fund I'll talk about later that is an outright sell.
Alpha Performance CEFs - Let's Talk Funds
The best opportunities I see are in fund's which may announce distribution raises heading into 2014. This is the one area that CEFs have an advantage of ETFs, especially right now when fund sponsors will begin declaring 4th quarter distributions and are much more likely to announce distribution adjustments for the upcoming year. One fund family that may see multiple distribution raises is from Gabelli.
Two Gabelli funds, the Gabelli Equity Trust (GAB) and the Gabelli Multi-Media Trust (GGT), both have 10% NAV distribution policies and are virtually a lock to raise their 4th quarter distributions, though these are one time distribution increases that won't necessarily carry over into 2014 though Gabelli may still adjust their regular distributions higher based on their NAV performance. The 10% NAV distribution policy makes up in the 4th quarter distribution any shortfall or windfall for the prior three quarters. For 2013, there should be a significant boost in the 4th quarter for both funds based on their strong NAV appreciations for the year. According to my calculations, GAB should have a 4th qtr. distribution of around $0.20/share, up from the $0.14/share for the prior quarters while GGT could have as high as a $0.32/share 4th qtr. distribution, up from $0.20/share for the prior three quarters.
Another Gabelli fund, the Gabelli Dividend & Income Trust (GDV) could be in line for another distribution raise even though it last declared a distribution raise just this past February, from $0.08/share to $0.09/share per month. But with the fund's NAV up a whopping 30.6% so far in 2013, there is certainly room for another considering its very low 4.6% NAV yield. If a raise doesn't happen this quarter, then Gabelli could raise next quarter when it raised a year ago.
One more Gabelli fund, the Gabelli Healthcare & WellnessRX fund (GRX) probably has more reason than any to raise its distribution because of its ridiculously low 3.5% NAV yield (compare that to GAB's and GGT's 10% target NAV yields annually). In the past, Gabelli has wanted to keep GRX as a "growth of capital" fund first and foremost, but with a rights offering this past July which boosted the fund's assets by $33 million to a current $202 million in total managed assets ($30 million of which is leveraged in preferred share debt), I believe Gabelli will now offset the lowered leverage percentage with a higher yield. The other reason why I feel Gabelli may want to finally raise GRX's distribution is because GRX is prone to very large end-of-year capital gain distributions, due in part to the number of mergers and acquisitions in the healthcare industry, and a raise in the distribution might be a better way to spread that out instead of in a lump sum.
If it wasn't for the rights offering this summer which was priced well below the fund's NAV and market price at the time and thus served to dilute GRX's overall NAV and market price (which was a great deal for existing shareholders BTW), GRX's total return NAV performance would be over 30% YTD - like GAB, GGT & GDV, instead of the 23.7% shown above. I believe GRX could easily handle a 50% increase in its distribution from $0.10/share per quarter to $0.15/share which would still give GRX a very low 5.2% NAV yield but a much more attractive 5.8% market yield based on the current discount.
Gabelli should declare 4th quarter distributions for their CEFs around Monday, November 18th.
What Are CEF Investors Thinking?
My recent articles since September have been focusing on the Allianz Global/PIMCO family of CEFs and the recent reorganizations of a few of their funds. I'd like to reiterate something that I have been pointing out of late since this is one of the more extraordinary market price actions I have seen for a CEF.
On September 25th, Allianz announced a merger between the Allianz Global Equity & Convertible fund (NGZ) and the Allianz Equity & Convertible fund (NIE) with NGZ, a much smaller fund, being absorbed into the larger NIE fund. If the merger is approved by shareholders of both funds, NGZ shareholders will get new shares of NIE based on the NAV ratio of the two funds.
Now NGZ's market price was initially down on this news since NGZ traded at a higher valuation than NIE and if NGZ shareholders were going to eventually get converted to NIE shares, than they would be receiving the lower discount valuation as well. However, NGZ shares have since skyrocketed up to a premium valuation. This is shown in the following YTD graph of NGZ and NGZ's NAV (XNGZX) in which NGZ's market price has shot upward to $17.10 even though its NAV is only worth $16.89 (as of 11/8/13).
According to the preliminary merger prospectus, which you can read here, (See Page 8 - 12. Will the number of shares I own change? and Page 36 - Capitalization showing reduced number of shares of the combined funds), NGZ shareholders WILL get the full value of their fund's NAV, currently $16.89, but they will get it in new market shares of NIE based on the NAV ratio of the two funds, currently about 76% ($16.89/$22.19). In other words, NGZ shareholders are going to get 76% of their current market shares of NGZ in new market shares of NIE. That's the way I read it and if that's the case, their NGZ shares are only worth $14.60 currently (76% of NIE's market price of $19.20), not $17.10.
Not surprisingly, $14.60 is about where NGZ dropped in the days right after the merger announcement but has since gone straight up over $17. I'm guessing forced buy-ins, short covering or just uninformed investors are what's driving NGZ's market price higher, but if you're a current holder of NGZ and if the merger is approved in early 2014, there's about a 15% difference in the market price today and what it is really worth if the merger is approved.
Note: This is how I am interpreting the preliminary merger prospectus and conditions may change, including the merger not being approved. I am also short a very small number of NGZ shares though I do NOT recommend an investor to short shares of NGZ.
Due to the length of this article, I will come back in a Part II of this series and discuss more equity CEF opportunities, both to the upside and downside, since after all...we're here seeking Alpha and not just to invest and match the performance of ETF index funds.