Owning Too Many CEFs Is a Bad Thing

I can recall in 2004, 2005 and maybe even in 2006, seeing many a closed end fund being launched with a celebratory bell ringing at the NYSE. Lately, there has been not so much of that, if at all.

There could be several reasons for this. The ETF/ETN format has become more popular, although not always superior. There was really a deluge of new listings, especially covered call funds, so that meant a lot of new supply. Lastly, panic in the market caused an overreaction in the market prices relative to the NAVs, which, by the way, is a common reaction in times of turmoil. I have repeatedly referred to June/July 2003 as an example of what can go wrong with CEFs and I think the last few months are another example.

CEFs are simply a tool. They have strengths and weaknesses. The big weakness is that they do overreact to market events and often end up disappointing people looking for safe havens.

I have several CEFs in my ownership universe. One has held up pretty well, a couple have been fair but not great, and another has been hit hard.

That a fund is down at a time that is bad for CEFs is not a bad thing in and of itself but, clearly, a bad asset allocation decision - viz. owning too many CEFs - is a bad thing.

I wrote countless posts and articles about call writing funds over the last 3 1/2 years as I buy into the concept. But in just about every post on this topic - I am hedging a bit here because I am pretty sure I did this every time but I can't be certain - I urged moderation, no more than 3-4% of the total. Most of them went down a lot and some of them are working their way back up faster than others. From where I sit, nothing has changed if the exposure was moderate, which it is in my case.

While many different types of CEFs have faltered, there have obviously been other things like commodities, agriculture and currencies that have generally worked to offset, or maybe more than offset, any decline from a CEF.

One contrarian thought that I am unlikely to pursue is whether or not the lack of new listings and the poor market action make this a good time to buy CEFs. This is not my type of trade, because I don't think I would be very good at gaming the narrowing of a fund's discount. I look at CEFs for very specific exposure as opposed to the broad nature in which the question is framed.

Comments

[RogerNusbaum]

The 5th paragraph was edited in such a way that the meaning may be different than intended.

From the original post on my blog;
"That a fund is down at a time that is bad for CEFs is not a bad thing in an of itself but clearly a bad asset allocation decision, IE owning too many of them, is a bad thing."

[User 171371]

33% of my portfolio are ETF's.They add some stability,great exposure and good dividends.The up and down side are limited but the divys make up for that.My one "balanced mutual fund" is in the dumpster with a poor monthly pay out ( my bad,I listened to my broker).

[d_teller]

I have CEFs and ETFs and the old-fashioned mutual funds and stocks, etc. But I'm drawing down the accumulation and using the dividends from the CEFs to cover the MRD's. So, I guess the approriateness of owning CEF's and their nature and quantity, depends upon what you expect from them...certainly not capital appreciation!

Secondly, it makes sense to purchase small allocations of diverse CEF's when they are trading at substantial discounts to their real, current net asset value...remember, the market value discount is based upon a dated NAV, sometimes 6 months outdated...imagine a CEF loaded with Ciiti, WAMU, Thornberg, BearStearns debt, and bought for its apparent yield, at a large discount in the Fall of '07...it will have an even larger discounted value now! Likewise with CEFs that have managed distributions.

But ...for an IRA setting, this is ideal, because a 10% distribution on a wasting asset class covers the MRD and doesn't provide a larger capital base to increase the increasing-with-age distributions.

Finally, some CEFs hold assets that are inaccessible via ETFs and/or mutual funds ...foreign securitities that are not tradeable to U.S. citizens, in countries that have little or no disclosure regulations. Here, you do depend upon the acumen and intelligence of the underwriters (as one might with a mutual fund) but these are fairly specialized. Compare CAF to GXC to FXI -and you can see the differences in the qualitative nature of the securities held by each from unheard of to B-shares to SOE's. These are held for diversification, not for yield, and they do that well. They are in a different "risk" and "expectation"... category from income-producing CEFs like GHI, ZTR or MCN.

[Whisper OnThe Wind]

I'm beyond the 3-4% but not even close to the 33%, probably closer to 12%, and those dividends are still coming. I try to stay away from the financial CEFs since I have financial stocks for that, and those are floundering like all the rest. But the energy/utility field seems to be doing okay for CEFs and I don't mind the lack of capital appreciation if they're continuing the dividends. When the stop the dividend, I will sell half and buy something else. Most of what went down is already starting back up anyway (in my portfolio).