How To Boost Returns In Closed-End Funds: 30% Annualized Since Publication

|
Includes: AWP, BTT, CAF, EMD, ESD, ETJ, EVV, HTD, IGD, IQI, MMT, NEA, NXJ, RNP, RQI, SPY, TLT
by: Fred Piard

Summary

I described on 4/14/2016 a CEF strategy based on proven market anomalies.

It selects 15 holdings on dividend yield, discount to NAV, mean reversion and momentum.

Here are out-of-sample performances of the model portfolio for the last 15 weeks.

I have published on 4/14/2016 an article describing a portfolio strategy in closed-end funds (hereafter CEFs). Academic research shows that closed-end funds with a positive discount to net asset value have historically outperformed the stock market, and that the discount has statistical properties of mean reversion. To make an exploitable strategy, I reduced the universe to closed-end funds with a share price above $5 and average daily volume representing more than $1 million. I consider only the CEFs with a positive discount to NAV and create 4 rankings:

  • Mean reversion: ranking on discount deviation from the average.
  • Value: ranking on discount to NAV.
  • Dividend: ranking on current yield.
  • Momentum: ranking on 1-year return.

Then rankings are aggregated to calculate a final ranking. The 15 best ranks are selected. When several CEFs get the same final rank, the most liquid in dollar amount passes first.

Backtest

The next chart and table shows a strategy simulation updating and rebalancing the portfolio in equal weight every week on opening from 05/01/2000 to 04/07/2016, reinvesting dividends and without trading costs.

Data and charts by portfolio123.

Turnover and transaction cost

This strategy has a drawback: turnover. On average, 25% of holdings changes every week. It makes the performance sensitive to transaction costs: not only commission, but also bid-ask spread and slippage. I have shown in the original article that an average transaction cost between 0.2% and 0.3% is realistic. The next table gives simulated annualized returns (hereafter CAGR) of the 15-holding portfolio with various rebalancing periods and transaction costs. Period is 05/01/2000 to 04/07/2016.

weekly

2-week

4-week

8-week

3-month

average turnover /period

25%

31%

40%

50%

55%

CAGR, no cost

23.83%

19.15%

15.79%

14.49%

12.07%

CAGR, 0.1% cost

20.58%

17.22%

14.58%

13.74%

11.58%

CAGR, 0.2% cost

17.42%

15.32%

13.39%

13.00%

11.08%

CAGR, 0.3% cost

14.34%

13.45%

12.21%

12.26%

10.59%

CAGR, 0.4% cost

11.34%

11.61%

11.04%

11.52%

10.10%

CAGR, 0.5% cost

8.41%

9.80%

9.88%

10.79%

9.61%

The portfolio rebalanced weekly to monthly with a 0.2% to 0.3% cost has a historical annualized return in the 12%-17% range. It is an excess return of 8% to 13% over SPY.

Initial state

The next table shows the holdings of the strategy when the first article was written.

Ticker

Name

AWP

Alpine Global Premier Properties Fund

BTT

BlackRock Municipal 2030 Target

CAF

Morgan Stanley China A Share Fund

EMD

Western Asset Emerging Markets Income

ESD

Western Asset Emerging Markets Debt

ETJ

Eaton Vance Risk-Managed Diversified

EVV

Eaton Vance Limited Duration Income

HTD

John Hancock Tax-Advantaged Dividend

IGD

Voya Global Equity Dividend and Premium

IQI

Invesco Quality Municipal Income

MMT

MFS Multimarket Income Trust

NPM

Nuveen Premium Income Muni Fund

NXJ

Nuveen New Jersey Divi Advantage

RNP

Cohen & Steers REIT and Preferred

RQI

Cohen & Steers Quality Income Realty

Out-of sample performance

The next table reports the performance of the strategy with various rebalancing periods between 4/15/2016 and 7/30/2016. Dividends and trading costs (0.25%) are included.

Rebalancing Period

15-week Return

Annualized Return

Max Drawdown

Volatility (weekly standard deviation)

Sharpe (weekly)

1-week

7.76%

28.74%

-2.21%

8.03%

3.29

2-week

8.19%

30.49%

-2.21%

7.60%

3.69

3-week

8.32%

31.05%

-2.28%

7.95%

3.45

4-week

10.16%

38.73%

-1.94%

8.00%

4.19

3-month

9.69%

36.71%

-2.57%

9.18%

3.40

SPY

4.90%

17.55%

-5.16%

7.21%

2.30

SPY+TLT*

6.72%

24.60%

-1.85%

7.92%

2.61

* equal-weight, rebalanced weekly, 0.1% transaction cost.

Conclusion

Academic research identifies two market anomalies in closed-end funds:

  • An excess return over the stock market when the discount to NAV is positive.
  • More excess return when betting on its reversion to the mean.

My strategy based on these anomalies, dividend and momentum has brought a significant excess return over SPY and SPY+TLT in equal weight since it was published on SeekingAlpha in April. Past performance, real or simulated, is not a guarantee of future returns and risks. If you are interested in the CEF model portfolio updates, tell me by clicking "Send Message" at the top of this article. It is available on another platform, not in my SeekingAlpha Premium Service. Anyway, you can click the "Follow" tab at the top of this article to get free updates of my Valuation Dashboards by sectors and industries and subscribe to my free Market Timing Signals.

Disclosure: I am/we are long RQI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.