What Will Happen to Closed End Funds?

 

I had an article about closed end funds run on TheStreet.com today.

The above chart was sent along to me in response to the article, by TFS Capital, which is the firm that runs the TFS Market Neutral Fund (TFSMX).

The point of my article was that in times of crisis (real or perceived), CEFs usually get crushed. I have a couple of CEFs in my ownership universe and they are no exception.

One reader left a couple comments calling CEFs weapons of financial destruction. Anyone owning too many of them would certainly feel that way. I used to write about them more when the ETF space was much smaller. I talked about moderation, which I believe is important in all aspects of investing, but it would not be surprising to hear about people owning too many of them. For some people, even one may be too many.

The chart shows the point made in the article. Every so often CEFs puke down and scare the hell out of people. After that, they either come screaming back or work back slowly. Coming back after this crisis is a good bet, but I have no idea if they will scream back or work higher slowly.

Comments

[22thoroughbred:]

I would think CEF's holding commercial paper would come back the fastest followed by ones that hold Agency Paper, any cogent thoughts?

2008 Oct 08 04:45 PM

[Drenched Al...:]

Certainly, on the surface there appear to be tremendous opportunities for income investors with a longer horizon but I still have some nagging questions in this credit environment. I generally like the leveraged municipal bond funds and still have a small position in NMZ which has dropped tremendously and closed today down 11.2% with a yield of 11.4% tax fee, just a month after Nuveen increased the payout. I'm reluctant to add to NMZ because it holds a lot of lower rated and unrated municipal debt, but I'm looking at some of the others that have also dropped precipitously like NXZ with AA average debt rating and shorter duration. The discounts on all of the leveraged municipal closed-end funds are getting huge. Aside from the upcoming strain on governments to meet their debt obligations, is there unusual extra risk right now with the funds due to their use of leverage (i.e. interest rate spreads or ability to maintain financing for leverage)? I see that discounts average substantially lower on Nuveen's unleveraged funds.

2008 Oct 08 05:56 PM

[User 276126:]

Being able to buy illiquid CEFs at significant discounts without driving up the price on oneself is one of the few advantages individual investors have over institutions.

2008 Oct 08 06:18 PM

[DEcho:]

I was disapointed to see the article didn't discuss any of the risks associated with CEFs. I have lots of them in my portfolio, and I understand the difficulties with leveraged CEFs, but any of the risks of doing a short index - buy discount non-leveraged CEF, was not discussed.. So what happens if an CEF sponsor goes down the drain ?

2008 Oct 08 07:46 PM

[brpinion:]

user 276126 is right. CEF's are the only place a small investor can make buys in illiquid securities at a huge discount without driving up the price. I have now sold all my stock holdings and bought NONleveraged CEF's trading at unbelievable discounts. You can buy term CEF's like BEP and RCC at over 15% discounts and they will mature at asset value in 15 months! Including the dividends (and covered calls the funds sell) this will give you well over a 25% return (even with a cut in the dividend) assuming a flat market. The market would have to fall more than 25% before you lose money if you hold till maturity.

Also, why buy oil when you can buy IRR at a 25% discount. Just don't buy on margin and stay away from the leveraged funds. Look at EXG, ETW, EOD, JSN, JPZ for examples of tremendous opportunity.

2008 Oct 08 07:47 PM

[TBill:]

I'm not worried about the leverage you want to avoid. Obviously, it gives you more bang for the buck. If the fund can't make money off the spread, it can get rid of the leverage.
I bot a bunch of CEF's after the Sep decline... wish I had waited. Now you can get discounts of 30%, as much as you can stand.

2008 Oct 09 10:41 AM

[Argent:]

Do you have any opinion as to why CEFs of municipal securities have been so pummelled in the market even though their dividends - coming from muni bonds - are about as secure as any out there?

2008 Oct 09 11:31 AM

[searcher:]

If you are comfortable with the asset base then these discounts are lifetime opportunities for those with liquidity. Seems truly foolish to also embrace leverage risk. But, hey, if you really want it all, go for the discounted leveraged CEF's on margin.

2008 Oct 09 11:33 AM

[User 7013:]

Is there going to be an end to all these useless articles from Roger Nusbaum? Seemingly, he only views this forum as a vehicle of personal PR at best and his ego trip at worst.

2008 Oct 09 12:33 PM

[pansyed:]

User 7013. So what if he is writing for PR? Do you think everyone else in this forum writes for your good?

Some of us derive information from what he writes. Sometimes the questions posed by others is more enlightening than an article. If you don't like the articles Roger writes why read them?

2008 Oct 09 01:14 PM

[Roger Nusbaum:]

Argent, what about California? Where there is one municipality there could be others.

User 7013, I don't write for 'PR.' While there is no talking someone out of a notion like yours, how is this one specifically PR? TSCM doesn't pay by the eyeball. Neither is there any sort of tout.

2008 Oct 09 02:25 PM

[richmcn:]

further to argent's point
I have noticed the NAV for VKQ go down 14 13 12 11 10 etc
Market price follows it down
Does VKQ have to sell any bonds in their portfolio for forced redemptions or is the muni market getting written down
thanks
rich

2008 Oct 09 10:42 PM

[BDHPlayer:]

You should take a look at the funds that invest in senior secured bank loans.

hedge funds are selling their investments in leveraged loans like there is no tomorrow. I'm guessing that the senior loans are now priced in the mid to low 70's.

On top of that you have discounts of 30% or so on these funds. Even accounting for leverage your buying a portfolio of leveraged loans in the mid 50's.

Using a default rate of 10% and a recovery rate of 50%, you come up with a loss of 5%. Using a 30% default rate, you come up with a 15% loss. Either way, it seems that the prices are way too cheap.

2008 Oct 10 01:25 AM

[Argent:]

First,to answer ROGER, don't understand your question. My comment/question covered ALL muni CEFs, not just CA.

Second, to answer "rich mcn," there are no "redemptions" of commom (or preferred stock). The oustanding shares are fixed and trade like any other stocks in the market. With respect to the NAV driving down the prices I don't agree. These products are bought primarily for their (tax-exempt) yield which comes from muni bonds in the portfolio regardless of whether the market value of those bonds declines - it's a fixed rate.
My own opinion as to why these stock prices are going down with the overall market, regardless of yields of up to 8.00%, is that many are selling to raise cash and the low daily trading volumes of many of them just get killed by the specialists who simply are afraid of them. Twas ever thus with these things, i.e., thin volume making selling difficult.
I look for the majors - Nuveen, Black Rock, Eaton Vance, etc. - to begin conversions to open end status. Of course they'd have to deal with the auction rate preferred stocks many of them use for leverage; but that's another story. I know Nuveen can buy stock in the open market if the NAV goes below a certain point and stays there for a certain number of consecutive days.

2008 Oct 10 05:09 PM