Joe Eqcome

CEFs in Cyclical Bottoming Process: Two Recovery Plays

JCarroll

According to FOF’s recent annual report, its net investment income was $.74 per share. So, its current distribution of $1.08 is 146% of its recurring income. The balance of ‘08’s distribution was a “return-of-capital” which diminishes its NAV per share by a similar amount.

If you based its future annual distributions on its current net investment income, it would be around a 9% distribution yield. That would be the yield on which I’d base my investment decision.

You’re correct regarding FOF’s expense ratio being in addition to that of the CEFs it holds. While I don’t have the exact expense ratio for its holdings, the average for the CEF market segment is 1.5%.(You should note that management expenses of its portfolio holdings are already imputed into their NAV calculations.)

Discounts vary with investor sentiment and market cycles and tend to be the widest at market bottoms. Typically, discounts tend to narrow when the market "turns-up" and accelerates the share price appreciation.

Because FOF owns CEFs that trade at a discount, FOF’s discount is a “discount on a discount”.

For example, if the average price of FOF portfolio holdings is $9.00 per share and its associated NAV is $10.00, then FOF’s imputed portfolio discount is 10%. Excluding the management fee for a moment, FOF’s NAV is 9.00 per share—the average share price of its portfolio holdings. If FOF trades at a discount of 10% to its NAV of $9.00 per share ($8.10), then it is trading at a 19% gross discount to the NAV of its portfolio holdings ($10.00). If you assume a management fee of 1% based upon FOF’s NAV of $9.00 per share, then the inherent portfolio discount is closer to 18%.

As noted above, one thing to keep in mind with thinking about the expense ratio and the NAV is the expense ratio is imputed into the posted NAV calculations. So, it is not necessary to assume a further deduction when looking at the calculated NAV per share. But it is appropriate in the previous example.

Here is a link to a report on FOF. Focus on the segment “Per Share Changes to NAV”.
joeeqcome.web.officeli...

I hope this is helpful.

Joe Eqcome

CEFs in Cyclical Bottoming Process: Two Recovery Plays

Asian-

I once asked a famous institutional investors how he had time to research individual financial stocks prior to purchase during the savings & loan stock market recover. His response was he didn’t. He said he bought the whole group and kicked the stocks out he didn’t like after he owned them. He added that he would have missed a powerful part of the segment’s initial market movement had he not proceeded in that fashion.

The contention of the article—rightly or wrongly—is that we may be on a verge of a “run” in the closed end fund segment for factors articulated therein. The proposition is that investors may be able to capture the early part of that powerful advance by participating in the highlighted stocks designed to capture the diversified characteristics of a diversified CEF Index.

While your point regarding the diversity of the CEF fund types is true, fund types are sub-sectors within the CEF market segment. Closed end funds are in fact a single market segment bounded by the regulations of the “40’s Act” that created them.

Early in a stock recovery cycle for any particular market segment—be it financials, industrials, REITs, techs, etc., all boats will rise in a fairly indiscriminate fashion. My task was to make its simple for less knowledgeable investors to participate in that early price movement through a single stock purchase.

It is during the subsequent phases of the CEF market cycle that knowledgeable investors like you will be needed to help us parse the various fund types.

Joe Eqcome

FOF: A Good Proxy for Owning the CEF Industry

CEFGuru

You referenced the Claymore CEF Index as some type of baseline for the closed end funds industry.

The monthly correlation to the CEF index I’ve constructed, in my article regarding FOF share price tracking the general price movement of CEF industry, has a price correlation of 95% (R^2) with the Claymore CEF Index.

The problem with the Claymore index is that it only goes back to March of 2002. My index goes back to 1979; on a same CEF basis to 1998.

Claymore’s CEF Index effectively excludes municipal funds as it excludes those funds that generate more than 50% of its assets in non-taxable securities. My index includes muni funds as CEF funds are proportionally represented over the 13 fund types employed by the WSJ.

The monthly price correlation between GCE and FOF is 99% since the beginning of 2008.

All things being equal, FOF is a far superior stock than GCE to play the price trends in the CEF market segment as it has: a longer price history (11/06 vs. 12/07 for GCE), FOF average daily volume is 84,500 for the last 10 days versus 647 shares for GCE, trading at a discount as opposed to a premium for GCE and both trade at a yield around 12-13% (both suspect). GCE hasn’t opened today.

My assertion that FOF is a single stock investment that would track the general price trends of a broad based CEF index remains substantiated by the facts.

Joe Eqcome



On Feb 20 11:34 AM CEFGuru wrote:

> First I think it is important to keep this on topic and avoid the
> personal jabs. Make fund of the pseudonym I choose, I can accept
> that but please stop there.
>
> Oldman said in his comment "closed end funds are bad investments."
> Now I don't completely agree with that but do know there is a shred
> a truth to the statement because too often we try to oversimplify
> the process of investing in closed-end funds for retail. Investing
> in closed-end fund requires painstaking investigation into the sponsor,
> fund objective, process, etc. There is not a magic pill, but if you
> choose to do the work it can be very profitable. I have done the
> work on FOF and will it is the first of its kind it is severly flawed
> in its appraoch to the closed-end fund space. And that was the genesis
> of my comments yesterday. But I will respond in order to set the
> record straight.
>
> My response is based on the fact that you purport FOF to be a proxy
> for the closed-end fund market, I respectfully disagree. I went back
> and looked at the correlation you described and added the correlation
> to the only publicly disseminated closed-end fund index. So here
> we go.
>
> The correlation you purport, if I understand, is a month end correlation
> as opposed to a historic daily one for the two products. Please let
> me know if I have misread this in your initial note. While I agree
> this is a very high correlation I'm not sure it stands the test of
> time. Further when i went to Bloomberg and looked at the FOF correlation
> since inception to PSQ I received a much different R^2. According
> to Bloomberg this number using monthly data is .358, weekly .39,
> and daily .361. Please let me know if I am missing something. When
> I looked at the corrlation to the NMUNI (seekingalpha.com/symbo...)
> and NMUNP (share price), which is the Nuveen Municipal CEF index
> the correlations were again very low, .354 and .35 respectively but
> the correlation to GCE was at .788 again using monthly data. So what
> does this tell me.
>
> First I believe the tagline "FOF A Good Proxy for Owning the CEF
> Industry" to be inaccurate. As the correlations tell me, using publicly
> available CEF indexes GCE (again GCE is an ETN based off a index
> which is more weighted toward the taxable CEF space) and NMUNP, FOF
> is not a good proxy for the overall CEF market. While it is better
> for the taxable funds (including Equity and taxable fixed income)
> it is not for the municipal space. And you need to get this granular
> when looking at the space because a CEF is a structure and not a
> strategy. Joe, your index may tell a different story but I don't
> have the data you used to comment.
>
> And while I agree with your correlation and causation statement,
> I don't agree that investors purchase FOF because it approximates
> the CEF market, rather I believe they purchase it for the same reason
> they purchase most other CEFs, the yield.
>
> In the end I think investors have to look deeper than an FOF if they
> are going to make sound investments in the CEF space so we, you and
> I, need to refrain from making statements that one fund is a good
> proxy for an entire universe of funds because it may have an unintended
> impact on the investing public. Let's not oversimplify investing
> in this space.

FOF: A Good Proxy for Owning the CEF Industry

Oldman

The average price decline for the CEF market segment for '08 was 37.7% vs 38.5% for the S&P 500. So, it was pretty much in line with the market in general. The fact that the distributions may have been comprised of capital gains and return of capital should be imputed into the price.

Longer term, you're correct. CEFs haven't been a particularly rewarding investment. An average price index of 58 CEFs all in continuous operation at the end of June 1998 was $13.20 per share. That same index is at the end of Jan '09 was $9.16 per share, off 30%.

Not a good way to make money.

Joe Eqcome


On Feb 19 08:44 PM oldman wrote:

> I think all closed end funds are bad investments. Just check your
> 1099 for 2008, lot of adjustments after you thought the distributions
> were earned and now are ROC. On top of that -50% losses.

FOF: A Good Proxy for Owning the CEF Industry

CEFGuru

Again, let’s review your comments by parsing them:

Comment: “First I think it is important to keep this on topic and avoid the personal jabs. Make fund (sic. fun) of the pseudonym I choose, I can accept that but please stop there.”

Response: My concern is more academic than personal on this point. I believe using the term “CEFGuru” is somewhat presumptuous. It implies you have some special knowledge or status. My legitimate concern is that someone who knows little about this CEF market segment might take your view as authoritative.

If you could demonstrate your superior knowledge by providing your credentials or recognition(s) from reputable third party institutions of your contributions to this market segment then it would be justified.

Comment: “My response is based on the fact that you purport FOF to be a proxy for the closed-end fund market, I respectfully disagree.”

Response: This is a free country and anyone can state their opinion, even if it’s incorrect. The point is to support your contention.

What I’ve purported is that the FOF is highly correlated to an monthly average price index of proportionally represent CEF fund types and have demonstrated that in a quantitative fashion. That is a fact!

Your response has been to provide here some random numbers and a misinformed view of the Claymore CEF GS Connect ETN (GCE).

Comment: “Further when i went to Bloomberg and looked at the FOF correlation since inception to PSQ I received a much different R^2. According to Bloomberg this number using monthly data is .358, weekly .39, and daily .361. Please let me know if I am missing something.”

Response: Yes you are. As you may know, depending what period and intervals are being observed, correlations can vary materially. For my purpose, an average monthly calculation of 130 CEFs out of a universe of 639 was appropriate for long-term investors looking to capture the price movement trends of the CEF market segment using a single stock (FOF) at this possible market inflection point.

Comment: “First I believe the tagline "FOF A Good Proxy for Owning the CEF Industry" to be inaccurate.

Response: I do not disagree that the tagline may be less than precise. I would have preferred that title along the lines of: “FOF Shares Prices Tracks Unweighted CEF Average of Index Proportionately Represented Fund Types.” However, Seeking Alpha has the final editing rights to the tagline and that is what they published.

Comment: “As the correlations tell me, using publicly available CEF indexes GCE (again GCE is an ETN based off a (sic. an) index which is more weighted toward the taxable CEF space)…”

Response: GCE would probably be a very poor proxy for the CEF industry for the following reasons: it has only been around for a little over a year, it has only $23 million in assets, it trades on average of approximately 1,000 shares a day and its current Bid for 100 shares at $.01 and its current ask for 100 shares at $201,000. I’d say that’s a pretty wide spread!

Additionally, because it’s an ETN, it would be biased by the fact that it is depended on the underlying credit of the sponsoring institution—all which has become suspect.

Comment: “And while I agree with your correlation and causation statement, I don't agree that investors purchase FOF because it approximates the CEF market, rather I believe they purchase it for the same reason they purchase most other CEFs, the yield.”

Response: FOF also has a yield. Investors have many reasons for investing.

Comment: “In the end I think investors have to look deeper than an FOF if they are going to make sound investments in the CEF space so we, you and I, need to refrain from making statements that one fund is a good proxy for an entire universe of funds because it may have an unintended impact on the investing public. Let's not oversimplify investing in this space.”

Response: This statement makes no sense at all. The key to successful investing and investment education is well articulated, designed and reproducible research. My assertion that the share price of FOF is highly correlated to the unweighted monthly index, as previously described, is quantifiably verifiable.

I believe the fact that anyone—informed or uninformed—can challenge that contention is the strength of our system. It is what makes the process work. (The CEF index is available for your review at my website under the “CEFIndex” tab at the hyperlink “CEF Historical Index Data”.)

Summary: I would agree to your point that the “tagline” could have been more precise. However, anyone reading the article would have understood that FOF tracks an unweighted broad monthly CEF index. And, if an investor would like to broadly participate in the general price change of the CEF market segment over a longer period of time (in terms of months, not days or minutes), FOF might be a stock to afford them that benefit . As I’ve made it clear before: I’m not saying that FOF represents the composition of the industry.

Your contention that shares of GCE is an investable proxy for the CEF industry is materially misleading to uninformed CEF investors.

Again, I would welcome some quantitative data marshaled in a systematic fashion to support any of your contentions.

Joe Eqcome



On Feb 20 11:34 AM CEFGuru wrote:

> First I think it is important to keep this on topic and avoid the
> personal jabs. Make fund of the pseudonym I choose, I can accept
> that but please stop there.
>
> Oldman said in his comment "closed end funds are bad investments."
> Now I don't completely agree with that but do know there is a shred
> a truth to the statement because too often we try to oversimplify
> the process of investing in closed-end funds for retail. Investing
> in closed-end fund requires painstaking investigation into the sponsor,
> fund objective, process, etc. There is not a magic pill, but if you
> choose to do the work it can be very profitable. I have done the
> work on FOF and will it is the first of its kind it is severly flawed
> in its appraoch to the closed-end fund space. And that was the genesis
> of my comments yesterday. But I will respond in order to set the
> record straight.
>
> My response is based on the fact that you purport FOF to be a proxy
> for the closed-end fund market, I respectfully disagree. I went back
> and looked at the correlation you described and added the correlation
> to the only publicly disseminated closed-end fund index. So here
> we go.
>
> The correlation you purport, if I understand, is a month end correlation
> as opposed to a historic daily one for the two products. Please let
> me know if I have misread this in your initial note. While I agree
> this is a very high correlation I'm not sure it stands the test of
> time. Further when i went to Bloomberg and looked at the FOF correlation
> since inception to PSQ I received a much different R^2. According
> to Bloomberg this number using monthly data is .358, weekly .39,
> and daily .361. Please let me know if I am missing something. When
> I looked at the corrlation to the NMUNI (seekingalpha.com/symbo...)
> and NMUNP (share price), which is the Nuveen Municipal CEF index
> the correlations were again very low, .354 and .35 respectively but
> the correlation to GCE was at .788 again using monthly data. So what
> does this tell me.
>
> First I believe the tagline "FOF A Good Proxy for Owning the CEF
> Industry" to be inaccurate. As the correlations tell me, using publicly
> available CEF indexes GCE (again GCE is an ETN based off a index
> which is more weighted toward the taxable CEF space) and NMUNP, FOF
> is not a good proxy for the overall CEF market. While it is better
> for the taxable funds (including Equity and taxable fixed income)
> it is not for the municipal space. And you need to get this granular
> when looking at the space because a CEF is a structure and not a
> strategy. Joe, your index may tell a different story but I don't
> have the data you used to comment.
>
> And while I agree with your correlation and causation statement,
> I don't agree that investors purchase FOF because it approximates
> the CEF market, rather I believe they purchase it for the same reason
> they purchase most other CEFs, the yield.
>
> In the end I think investors have to look deeper than an FOF if they
> are going to make sound investments in the CEF space so we, you and
> I, need to refrain from making statements that one fund is a good
> proxy for an entire universe of funds because it may have an unintended
> impact on the investing public. Let's not oversimplify investing
> in this space.

FOF: A Good Proxy for Owning the CEF Industry

brpinion

Yes, FOF does charge a management fee.

It’s my understanding that the management fee is already imputed into the calculation of the NAV. (See the “Financial Highlights” for any CEF’s N-CSR or N-CSRS filed with the SEC for the mechanics of calculating NAV.)

So, when you purchase a CEF share at a particular discount to its NAV, the management fee is already included in the calculation at the time of purchase. So, a calculation of additionally subtracting the management fee from the discount at the time of purchase would be the equivalent of double counting?

Beyond the mechanics of management fee, your reason for not buying FOF is due to the management fee being too high relative to its discount. Let’s assume that you’re analytically correct—that you should reduce the share discount by the management fee. FOF trades at a discount of 6.1% as of 2/18/09. If you were to subtract the 1% management fee (fee actually .95%) from the discount you’d get 5.1% net discount. That would be the equivalent of paying $.09 per share more for the stock ($8.58 vs. $8.49). That doesn’t sound too onerous to me.

Thanks for your comment.

Happy trails and successful investing!

Joe Eqcome

On Feb 18 10:20 PM brpinion wrote:

> forgot to mention FOF charges a management fee thus you are paying
> a management fee on funds that also charge a management fee. As such
> the expense of owning fof is to high for me for that little of a
> discount.

FOF: A Good Proxy for Owning the CEF Industry

CEFGuru

Let’s deconstruction your comments for purpose of analyses:

Comment: “I would be interested in understanding this "unweighted CEF price index" a little better.”

Response: The index is composed of the top 10 CEFs by NAV in each of the WSJ’s 13 CEF classification. The goal was to capture those CEFs that were most widely owned and to evenly weigh the classifications.

Comment: “A quick look at FOF holdings tells me I can't use it as a proxy for the CEF market because it excludes the largest sector of the market, municipals.”

Response: The fact that the 13 CEF categories were proportionally represented would mean that municipals were not overweighed in the index.

Comment: “Check out the FOF website. In addition, how many of its holdings are actually earning their distribution as opposed to trading principal for income? A look at the tax center for FOF shows that nearly half of every distribution (48%) for this fund was a return of capital in 2008. Further, most of the remainder is in the form of short-term capital gains.”

Response: I’m not sure this comment is germane. My article doesn’t profess that FOF’s holdings are similar to the industry’s holdings. What it professes is there is a price correlation between FOF’s share price and the unweighted index which is proportionate over 13 WSJ categories; and, I can quantitatively support that conclusion.

As any investor knows there is no causation in correlation. It appears that investors’ rightly or wrongly purchase FOF because they believe it approximates the market as the index represents. (There is a positive correlation between diaper rash and road construction in the UK; both caused by summer.)

Comment: “In the end I would conclude based on these facts and others that FOF is not a good proxy for the CEF market.”

Response: Let’s review your facts. Based upon your observation that the portfolio of FOF does not approximate the composition of the CEF industry—as you define it (how have you defined it?), FOF’s share price does not have a strong relationship with the general price movement of the CEF market segment.

It seems to me your conclusion is akin to describing an elephant my touching its tail.

I would warmly welcome any quantitative proof to support your conclusion. I would assume that in your vaulted status as a “CEFGuru” you’d be able to get your hands on the data to disprove my simple contention: that FOF shares track move in close harmony with the CEF industry.

I await your submission.

Happy trails.

Joe Eqcome



On Feb 19 08:51 AM CEFGuru wrote:

> I would be interested in understanding this "unweighted CEF price
> index" a little better.
>
> A quick look at FOF holdings tells me I can't use it as a proxy for
> the CEF market because it excludes the largest sector of the market,
> municipals. Check out the FOF website. In additon, how many of its
> holdings are actually earning their distribution as opposed to trading
> principal for income? A look at the tax center for FOF shows that
> nearly half of every distribution (48%) for this fund was a return
> of capital in 2008. Further, most of the remainder is in the form
> of short-term capital gains. Why? Because this fund overweights equity
> based CEFs which promise distributions based on their ability to
> generate gains, which as we know was difficult in 2008.
>
> In the end I would conclude based on these facts and others that
> FOF is not a good proxy for the CEF market.