Fixed-income CEFs still on sale

The average discount on close-end bond funds is a historically large 6.5%, writes Brendan Conway in Barron's, and the discount on the roughly dozen funds launched in the last year is even higher at 8.6%. Investors are likely correct in being wary of new products - especially at a time when interest rates look to be headed higher - but a couple of funds from the class of 2013 may be worth a look.

"We like fear, and we like dislocations in the marketplace," says Patrick Galley, CIO of RiverNorth Capital Management. He's a buyer of Pimco Dynamic Credit Income Fund (PCI), managed by rising star Dan Ivascyn. PCI is up 2.6% YTD, but NAV is higher by 4%, and buyers get a discount to NAV of 8% and a distribution rate of greater than 8%.

Galley isn't alone on this one. Boaz Weinstein's hedge fund has piled in as well, becoming PCI's largest single owner. Weinstein has bought major chunks of other funds as well, and Pine River Capital picked up a big slice of another of the class of 2013 - the DoubleLine Income Solutions Fund (DSL). The entry of hedge funds into the $250B closed-end arena - a market too small for most institutional investors - is another sign of bargains to be had.

David Tepper of Tepper Capital Management (not that Tepper) has identified the "1,000 x 1,000" club - bond CEFs trading at discounts of 10% or more which have seen NAVs rise by 10% or more over the last year. One of the class of 2013 makes the list - the BlackRock Multi-Sector Income Trust Fund (BIT).

Comments (18)
  • Tschurin
    , contributor
    Comments (381) | Send Message
    I'm guessing some of these discounted CE funds are leveraged and also am guessing that a lot of the leverage is done at the short-end of the yield curve. How will the expected rise in short-term rates impact those funds' returns going forward?
    5 Apr 2014, 10:01 AM Reply Like
  • King Rat
    , contributor
    Comments (1902) | Send Message
    Good question. Duration (to maturity) is also important.


    1) How leveraged are they?
    2) What is the average duration of borrowing?
    3) What is the average duration of buying?


    If they are leveraged 4-3 but are borrowing at 2% for 11 years out but collecting 5% for 12 years out, I would not be so worried as leveraged 4-1, borrowing 1% for 1 year out and collecting 6% for 22 years out.


    In the latter you risk leverage, rising borrowing costs, and falling market value of existing holdings. Longer duration bonds have generally higher yields, but also higher risk associated with varying yields of new, similarly rated bonds. That risk magnifies the risk associated with leverage.


    Discount to NAV can be a trap indeed, though I would be curious to know more in this case.
    5 Apr 2014, 02:52 PM Reply Like
  • Robert Hairgrove
    , contributor
    Comments (517) | Send Message
    Discount to NAV, IMHO, is only a trap if it never narrows. That is the challenge, to look at both NAV and price and try to determine what the relative performance is.


    Basically, you want to buy when the discount is large and sell when it approaches NAV (or after the discount changes to a premium). With some of these funds, it never completely closes, so you want both the NAV and the price to trend upwards. If NAV is flat, then look at the price ... however, price usually follows NAV, so I tend to look mostly at NAV regardless of the price. Price will eventually catch up with the NAV, all else being equal.


    I would stay away from funds with a declining NAV ... usually because the discount also tends to widen downwards.
    5 Apr 2014, 05:40 PM Reply Like
  • june1234
    , contributor
    Comments (4504) | Send Message
    There's a reason they selling cheap they'll get cheaper
    5 Apr 2014, 10:23 AM Reply Like
  • Gratian
    , contributor
    Comments (3627) | Send Message
    There's also a reason smart money is buying when they are cheaper.
    5 Apr 2014, 03:58 PM Reply Like
  • berloe
    , contributor
    Comments (2229) | Send Message
    I wonder what the investors in a hedge fund that invests their money on CEFs is thinking? Are they paying 2% plus profits to the manager to buy a CEF paying 8%?
    Count me out.
    5 Apr 2014, 12:47 PM Reply Like
  • Robert Hairgrove
    , contributor
    Comments (517) | Send Message
    With CEFs, expenses are deducted before distributions are paid. In general, I try to find funds which have less than 1% expense ratios. But if they are doing well, a higher expense ratio shouldn't bother you because you never really see that.


    For example, I am long HIH (a high-yield bond fund). If you invested back in September '13 as I did when it was still very cheap (around $8), the yield today on that investment (distr. = 0.065 per share, each month) would be 9.75%. Price and NAV appreciation has also been very good (abt. 9%, maybe 12% if annualized). Their expense ratio is about 2.5%. They do use 28% leverage, but it doesn't bother me. Many stocks are actually leveraged much higher than that, but nobody seems to worry about it (or do they?).


    A lot of the time, though, you have to be careful about the tax-relevant make-up of the distributions (income/LTG/ROC). It requires a lot of DD to cherry pick the good ones. Especially to determine - if there is ROC, whether it is beneficial or destructive. HIH pays all of its distributions as taxable income, so it would do nicely in a tax-advantaged portfolio (IRA, etc.)


    Go to ... lots of CEFs are still going for discounts between -5% and -10%. Check it out!
    5 Apr 2014, 01:17 PM Reply Like
  • Gratian
    , contributor
    Comments (3627) | Send Message


    Good advice in your comment. My current CEF allocation is currently overweight, so I'll have to wait for a while.


    Cef's are great to buy when they are unloved and great to lighten up for gains when they are more loved.


    Best wishes, gratian
    5 Apr 2014, 04:00 PM Reply Like
  • Scooter-Pop
    , contributor
    Comments (4967) | Send Message
    If you are in the maximum Tax Bracket there are 11% to 9% tax equivalent yields in the Muni CEF space!
    5 Apr 2014, 05:48 PM Reply Like
  • Gratian
    , contributor
    Comments (3627) | Send Message


    I agree, I have the Muni CEF's in my taxable trust accounts. Best wishes, gratian
    7 Apr 2014, 09:20 PM Reply Like
  • FinalAnalysis
    , contributor
    Comments (487) | Send Message


    Would you share Muni CEF favorites?


    Thanks much!
    5 Apr 2014, 06:13 PM Reply Like
  • Scooter-Pop
    , contributor
    Comments (4967) | Send Message
    Presented by portfolio weight after Friday's market close.


    HYD has maximum weighting and is the only MUNI ETF and ATAX (common shares) is a worthy mention due to current weighting in the portfolios under management.
    6 Apr 2014, 03:22 AM Reply Like
  • FinalAnalysis
    , contributor
    Comments (487) | Send Message
    Thanks for your ideas.
    7 Apr 2014, 11:39 AM Reply Like
  • old guy novice
    , contributor
    Comments (96) | Send Message
    I hold both DSL and PCI. PCI 3 times DSL holding. This article caused me to do a comparison more carefully.


    According to most recent info I could find on each website the funds have similar leverage; 30%-34% or so. I am relatively new to this but from what I can tell on their websites, the real difference I found was in the ratings of their dept.


    DSL has 73% unrated of which a very large percentage in emerging markets.
    PCI has only 8% unrated debt.


    Given the Debt ratings diference I wonder why their discount to NAV is so similar.
    6 Apr 2014, 01:38 PM Reply Like
  • Robin Hewitt
    , contributor
    Comments (5671) | Send Message
    Looked into this space over the weekend. It does look interesting but I'd look for better choices than BIT. They're returning capital in their distributions.


    Agree strongly with bobhairgrove that what matters is not the delta to NAV but current v historical delta to NAV. Some of the riskier funds always have a substantial delta to NAV.


    I'm not an expert in this area but found two funds that looked appealing: AWF and ESD. Both are 8% leveraged, which seems quite conservative. Neither has returned capital over the past year.


    AWF has a long upward trend history and flirts more closely with its NAV. It returned a substantial extra (make-up) distribution end of 2013. The current discount is in-line historically but I bought anyhow because I want to diversify somewhat away from U.S. equities given their dramatic run up. Will add if I see a better discount.


    ESD is higher risk, emerging markets national debt. Its large (11%) discount to NAV reflects that risk, but I like having a small exposure to EM at this time so I bought a small position there too.
    7 Apr 2014, 10:58 AM Reply Like
  • GoguPintenogu
    , contributor
    Comments (84) | Send Message


    What do you think of EHI, looks like a crossover of ESD and AWF (or HIX), has more leverage (24%), also higher distribution in excess of 9% and no ROC?
    9 Apr 2014, 10:20 PM Reply Like
  • Robin Hewitt
    , contributor
    Comments (5671) | Send Message
    Hi Gogu,


    I'm not expert enough in CEF bond funds to be offering advice but it looked to me as if EHI might be in a long term downtrend. I had some concern about that with ESD too but the tendency is stronger in EHI. Add in leverage, and the higher yield would not justify the risk of capital loss for me. But that's just my perspective.
    10 Apr 2014, 08:42 AM Reply Like
  • Decider
    , contributor
    Comments (1995) | Send Message
    Is PCI the most superior HY income CEF judging form its size?
    1 Apr, 02:28 AM Reply Like
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