CEF Investment Grade Funds: Solid Investment for the Current Turmoil?

Includes: BHK, BNA, JHS, LQD, VBF
by: Joe Eqcome

Summary: Despite the significant diversity in the closed end fund (CEF) market sector, the CEF sub-indices (Equity, Fixed Income, Muni and Other) converged during the current cyclical market decline (see graph below). This behavior was markedly different from the previous market trough of October 2002. Preceding the 2002 market trough, the CEF Equity sub-index declined but the other sub-indices held their ground.

Divergent Times: The likely cause of this divergence between the current stock market swoon and the 2002 trough was the previous market downturn was driven by the bursting of the internet stock bubble. This “tech wreck” was more of an equity driven phenomenon. The current downturn is one generated by a credit crisis touching all CEF fund types.

CEF Investment Grade Funds: Most pundits predict the credit markets need to improve prior to equity markets recovering. If that’s the case, then investment grade bonds should be among the first to benefit from a general improvement in credit conditions.

The table below lists CEF fixed income funds that invest a significant portion of their assets in investment grade bonds.

Selection Criteria: This list was screened for CEF investment grade bond funds where total assets were over $200 million and there were no preferred shares outstanding. With the exception of VBF, the other funds in the table can employ leverage.

Management fee is something to be considered when looking at CEFs. This is particularly true if the investment is of a longer term nature. It is less important for short term trading purposes.

As noted in the adjacent table, both BHK and BNA have very high management fees.

There is also an ETF, LQD, which invests in a passive index of investment grade bonds (iBoxx $Liquid Investment Grade Index). It has a $4 billion net asset base and a .15% management fee that may be an attractive alternative for long-term investors.

Disclosure: Author owns JHS and VBF