Based on the average historical premium/discount of 595 closed-end funds (CEFs) with 5 or more years of continuous operations, the following 10 CEFs (table below) have the largest deviation from their average historical premium/discount.
If these stocks were to gravitate to their historical mean, all other things being equal, the average share price would decline 23.1%.
The average premium/discount spread (current discount – average historical discount) for all 595 CEFs was 2.7%. The average for the 10 CEFs in the table below is 29.4%. Click to enlarge
(Click to enlarge)
Gravitation to the Mean: One powerful investment trend is called “gravitation to the mean.” In the case of CEFs, this simply means that over the long-haul these stocks will have a tendency to move towards their average historical premium/discount.
Commonality of Composition: Four of the top 10 CEFs listed above are sponsored by Pimco, and two are Cornerstone related funds. In a yield barren investment environment, investors seeking income have pushed up the share prices of CEFs with high distribution yields. They’ve done this with little regard for the share price relationship to its NAV and apparently without concern regarding the composition of the distribution.
And the Losers Are: In the case of both Cornerstone funds (NYSEMKT:CRF) and (NYSEMKT:CLM) and the Gabelli Utility Trust (NYSE:GUT), the distributions are made up almost entirely of return-of-capital (NYSE:ROC) distributions. The column “DistrYld” in the table is the total distribution including net investment income, capital gains and ROC. The column entitled “DistrYldNII” excludes estimated ROC. In the case of the aforementioned CEFs, the DistrYldNII is sub -1% return-on-investment. The balance just gives you your own money back.
Pimco: Pimco manages four of the 10 CEFs with the largest deviation from their respective means. One could possibly understand why investors might be comforted by that fact. Additionally, Pimco CEFs are still generating an attractive yield after the ROC distribution is eliminated from the distribution calculation (DistrYldNII).
An Investment Mystery: However, the two Cornerstone funds that are selling at a premium are an investment mystery. There appears to be no investment thesis to support their premiums other than nominal yield.
Particularly puzzling is the Cornerstone Total Return Fund (CRF). The fund has only $21 million dollars in assets; its investment portfolio is essentially large cap stocks, which you could buy cheaper and with more liquidity in the S&P 500 EFT (NYSEARCA:SPY); its return-on-investment yield of less than 1% (DistrYldNII); it’s thinly traded (average daily volume 20,000 shares). Yet it trades at a 45% premium versus its average year-end historical premium of 3.6%. Based on this information alone, CRF should be selling at a significant discount to NAV—not at a premium.
Bringing in the Calvary: Additional support for this position is provided by a Wall Street Journal article entitled: “High Yields Aren’t Always a Good Thing” (2/20/10). It spoke of investors chasing nominal high-yields of CEFs with large premiums.
One of its focuses was on Gabelli Utility Trust (GUT). It noted that while 90% of its distribution was a ROC, it still traded at a 60% premium. The following quote is from that article by GUT’s manager, Mario Gabelli on those very topics:
One could argue whether that’s good or bad. But I personally think the premium is unsustainable. It’s off the wall.
I wonder if Bill Gross would agree with Mario’s conclusion regarding Pimco’s CEFs in the table above.
Caveats: The return-of-capital portion of a CEFs distribution is typically estimated during the year in which it is made and is then finalized at year’s end. The ROC calculations could change materially upon closing of the 2009 books for these CEFs. Additionally, using a shorter, uniform average historical premium/discount rather than since inception for each of the CEFs may have produced different results.
Disclosure: No positions