Muni Funds, PGP And An Underpriced China Fund: CEF Weekly Update

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Includes: ACP, ACV, ADX, AFB, AFT, AGD, AIF, AKP, AOD, APB, APF, ARDC, ASG, AVK, AWF, AWP, BAF, BANX, BBF, BBK, BBN, BCV, BCX, BDJ, BFK, BFO, BFY, BFZ, BGB, BGH, BGT, BGX, BGY, BHK, BHV, BIF, BIT, BJZ, BKK, BKN, BKT, BLE, BLH, BLJ, BLW, BME, BNJ, BNY, BOE, BPK, BQH, BSD, BSE, BSL, BST, BTA, BTO, BTT, BTZ, BUI, BWG, BXMX, BYM, BZM, CAF, CBA, CCA, CCD, CEE, CEM, CEN, CEV, CGO, CH, CHI, CHW, CHY, CIF, CII, CIK, CLM, CMU, CRF, CSQ, CTR, CUBA, CXE, CXH, DBL, DDF, DEX, DFP, DHF, DHG, DHY, DIAX, DMB, DMF, DMO, DNI, DNP, DPG, DSE, DSL, DSM, DSU, DTF, DUC, EAD, ECC, ECF, EDD, EDF, EDI, EEA, EFF, EFR, EFT, EGF, EGIF, EHI, EHT, EIA, EIM, EIO, EIP, EIV, EMD, EMI, EMJ, EMO, ENX, EOD, EOI, EOS, EOT, ERC, ETB, ETG, ETJ, ETO, ETV, ETW, ETX, ETY, EVF, EVG, EVJ, EVM, EVN, EVO, EVP, EVT, EVV, EVY, EXD, EXG, FAM, FAX, FCO, FCT, FDEU, FEI, FEN, FEO, FFA, FFC, FGB, FHY, FIF, FIV, FLC, FMN, FMO, FMY, FOF, FPF, FPL, FRA, FSD, FUND, GAB, GAM, GBAB, GCV, GDL, GDO, GDV, GER, GF, GFY, GGM, GGN, GGT, GGZ, GHY, GIM, GLO, GLU, GLV, GMZ, GNT, GOF, GPM, GRR, GRX, GUT, HEQ, HIE, HIO, HIX, HNW, HPF, HPI, HPS, HQH, HQL, HTD, HTY, HYI, HYT, IAE, IAF, ICB, IDE, IFN, IGA, IGD, IGI, IGR, IHD, IHIT, IID, IIF, IIM, INB, INF, IQI, IRL, IRR, ISD, IVH, JCE, JDD, JEQ, JFR, JGH, JHA, JHB, JHD, JHI, JHS, JHY, JLS, JMF, JMLP, JMM, JMT, JPC, JPI, JPS, JQC, JRI, JRO, JRS, JSD, JTA, JTD, KED, KF, KIO, KMF, KMM, KSM, KST, KTF, KYE, KYN, LDF, LDP, LEO, LGI, LOR, MAB, MAV, MCA, MCI, MCN, MCR, MEN, MFD, MFL, MFM, MFT, MFV, MGF, MGU, MHD, MHE, MHF, MHI, MHN, MIE, MIN, MIW, MIY, MMD, MMT, MMU, MMV, MNE, MNP, MPA, MPV, MQT, MQY, MSD, MSF, MSP, MTT, MUA, MUC, MUE, MUH, MUI, MUJ, MUS, MVF, MVT, MXE, MYC, MYD, MYF, MYI, MYJ, MYN, MZA, MZF, NAC, NAD, NAN, NAZ, NBB, NBD, NBH, NBO, NBW, NCA, NCB, NCV, NCZ, NDP, NEA, NEV, NFJ, NHA, NHF, NHS, NID, NIE, NIM, NIQ, NJV, NKG, NKX, NMI, NML, NMS, NMT, NMY, NMZ, NNC, NNY, NOM, NPN, NPV, NQP, NRK, NRO, NSL, NTC, NTG, NTX, NUM, NUO, NUV, NUW, NVG, NXC, NXJ, NXN, NXP, NXQ, NXR, NYH, NYV, NZF, OIA, OPP, PAI, PCI, PCK, PCM, PCN, PCQ, PDI, PDT, PEO, PFD, PFL, PFN, PFO, PGP, PGZ, PHD, PHK, PHT, PIM, PKO, PMF, PML, PMM, PMO, PMX, PNF, PNI, PPR, PPT, PSF, PTY, PYN, PZC, QQQX, RA, RCS, RFI, RGT, RIF, RIV, RMT, RNP, RQI, RVT, SBI, SCD, SMM, SOR, SPXX, SRF, SRV, STK, SWZ, SZC, TDF, TEI, THQ, THW, TLI, TPZ, TSLF, TTP, TY, TYG, USA, UTF, UTG, VBF, VCF, VCV, VFL, VGI, VGM, VKI, VKQ, VLT, VMM, VMO, VPV, VTA, VTN, VVR, WEA, WIA, WIW, ZF, ZTR
by: Michael Foster Financial Services
Summary

Muni funds are oversold because of fears that tax cuts will lower demand.

Foreign funds are likely to see a strong 2018 thanks to a sustainable, fundamentals-driven rise in 2017.

PGP may see a strong start to 2018, but the price gains aren't sustainable.

The CEF Insider indices have seen a bit of a recovery in demand for equity funds, while bond funds take a bit of a pause:

Muni bond funds are selling off in large part because of the passed tax bill, although this makes no sense at all. Muni bonds sold off previously because of fears that PAB bonds would be treated differently in the new legislation, but then when the tax deal that passed treats PAB bonds as before, the muni bond market continues its sell-off. Obviously, the PABs were an excuse and not the real motivation behind people's desire to sell.

What is really driving this selloff? Perhaps it's something more subtle: investors believe municipal bond demand is going to be depressed in the future because the lower tax rates in the new legislation means less people will want to buy municipal bonds. That and the tight spreads on municipal bonds versus LIBOR and short-term Treasury rates also means limited benefit from leveraged municipal bond funds (i.e., leverage can increase returns, but by less than it used to). That all translates into people selling munis and muni bond CEFs.

Municipal bond discounts remain rather small, however-at 5.1%, which is less than the 11.7% average for corporate bond funds or 6.7% for high-yield bond funds (note the smaller discount for high yield is probably a symptom of yield reaching). Municipal bond funds started 2017 with a 4.2%, which was itself smaller than the long-term average discount for these funds over the last decade. It is apparent that demand for municipal bonds are temporarily depressed by the tax news, but the long-term trend shows demand for municipal bond CEFs is going up.

Biggest Discounts

The most discounted funds remain squarely in the equity world, but the discount of one fund bears particular mention:

Symbol

Fund Fees

NAV

Price

%Premium/Discount

Market Yield

Long-Term CAGR

DNI

1.69%

$16.87

$13.38

-20.69%

4.48%

2.87%

RIF

2.24%

$22.94

$18.80

-18.05%

7.02%

2.05%

CAF

1.89%

$27.73

$22.97

-17.17%

0.30%

5.07%

GAM

1.24%

$40.77

$34.30

-15.87%

1.40%

4.21%

EGIF

2.82%

$19.57

$16.55

-15.43%

5.29%

-1.64%

BIF

1.43%

$12.99

$11.00

-15.32%

3.73%

5.06%

GDL

4.68%

$11.60

$9.83

-15.26%

4.07%

3.95%

GGZ

1.63%

$14.61

$12.46

-14.72%

0.96%

4.51%

PEO

0.79%

$23.17

$19.77

-14.67%

6.27%

-0.43%

ADX

0.62%

$17.62

$15.08

-14.42%

6.90%

6.49%

These are familiar names with very little in common when you look at them closely. Some funds are good, some are bad, but the one that really sticks out for me is CAF. Look at the fund's NAV and price return for 2017:

As long-term readers know, I'm constructive on foreign assets and emerging market CEFs in particular. I see the gain in Chinese assets in 2017 as significantly more sustainable than the 2015 bubble and subsequent crash, which was driven by a lot of homegrown speculation from the still-emerging middle class.

Short-term, the emergence of a broad base of retail investors, many of whom are new to investing, is usually a bad thing for any asset. But the gain in Chinese assets is being driven in part by exogenous trends like the weaker dollar and endogenous trends like a more sustainable growth rate due to a successful "soft landing." Additionally, if Matt Levine is right and speculation is going to cryptocurrencies and away from stocks, the asset classes that tend to attract the most speculation (emerging markets are one) should see price trends more in line with fundamentals than with speculative frenzy.

This is good for CAF, which has proven itself in terms of NAV growth, while the recent special distribution did a very good job of bringing price gains close to NAV gains for 2017, which also means its discount has reached an extreme low. I do not own CAF but may initiate a position in the new year if last-minute tax-loss harvesting drives the fund down even lower.

Biggest Premiums

Symbol

Fund Fees

NAV

Price

%Premium/Discount

Market Yield

Long-Term CAGR

PGP

3.22%

$11.18

$15.09

34.97%

11.67%

10.40%

GUT

1.67%

$5.31

$7.00

31.83%

8.57%

6.25%

PCQ

1.29%

$14.06

$17.28

22.90%

5.35%

8.27%

PCK

1.38%

$8.59

$10.15

18.16%

5.59%

4.26%

RCS

1.53%

$7.69

$8.80

14.43%

9.82%

10.98%

CRF

1.45%

$13.20

$15.09

14.32%

18.30%

4.55%

DMO

2.58%

$21.51

$24.55

14.13%

11.00%

14.78%

PCN

1.08%

$15.12

$17.15

13.43%

7.87%

14.54%

CLM

1.30%

$13.55

$15.35

13.28%

18.49%

4.68%

PDT

1.93%

$15.27

$17.24

12.90%

6.79%

15.26%

In terms of overpriced funds, 2017 has caused the expensive to become more expensive in many cases. PGP is something of an aberration, which proved to be a really compelling contrarian and counter-intuitive short-term trade in early 2017 (which, sadly, Douglas Albo didn't approve of, but that's okay--I still deeply respect him and his work).

Nonetheless, when it comes to premium-priced funds, PGP has done the best job in providing value to shareholders:

Its NAV return is far in excess of other premium-priced funds despite paying an 11.7% dividend yield (at current price).

For this reason, I don't consider PGP a ticking time bomb, which is why it isn't in my list of top three funds to sell in 2018. In fact, I'll even go so far as to say that PGP may get a short-term bump in early 2018 that will probably prove unsustainable by mid or late 2018, depending on market conditions and the velocity of its price gains. The fact that we won't see a dividend cut at least until the end of 2018 (probably longer) will also help its premium jump even higher. Short-term trading CEFs isn't for the faint of heart, however, and it isn't a retiree's game. But it is a game that can be played profitably.

How to Use This Information

I write these weekly reports as a starting point for CEF investors to get a sense of which funds are most and least popular and whether there is a unifying force behind those relative popularities. Additionally, tracking the total return and market performance of CEFs provides investors with an idea of how and when these funds can be used as investment vehicles for a superior total return or a high rate of sustainable income.

This glance at the market is only a first step, however. A variety of other due diligence processes are necessary for CEF investors, including an analysis of NII, a look at management, an analysis of the fund's portfolio, changes to the fund's mandate, changes in and uses of leverage, and overall long-term and short-term fund performance. While some CEF investors like to use other metrics to make CEF purchasing decisions, such as recent tender offers, activist investments, insider trading, and Z-scores, it remains to be demonstrated whether those factors are predictive of future CEF returns and thus should be considered with caution.

Disclosure: I am/we are long BIF. 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.

Additional disclosure: We are also long ADX.