The Chemist's CEF Report - May 2018: Fixed Income CEFs Continue To Get Cheaper Vs. Equity CEFs

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Includes: ACV, ACWX, AGC, AVK, AWF, BUI, CEN, CET, CEV, CHY, CLM, CRF, DDF, DHY, DIAX, DMO, DNI, DNP, DPG, DSE, ECC, EDD, EDF, EDI, EGIF, EMD, EOI, EOS, EVJ, EXD, FAM, FAX, FDEU, FHY, FMY, FPL, FSD, FT, FTF, FXBY, GAM, GCH, GCV, GDL, GHY, GLO, GRF, GRR, GRX, GUT, HFRO, HQH, HTD, HYB, ICB, IF, IGR, INF, IRL, ISD, JMM, JNK, JRI, JRS, KST, LCM, LDF, LQD, MCN, MFL, MIE, MIY, MNE, MUB, MVF, MVT, NAZ, NBW, NCV, NCZ, NDP, NHS, NMZ, NNC, NQP, NTG, NUM, NUO, NXJ, OXLC, PCF, PCM, PCN, PCQ, PEO, PFL, PGP, PHK, PTY, QQQX, RCS, RIF, RIV, RNP, RVT, SPXX, SPY, TDF, TEI, TLT, TWN, TYG, VGI, VLT, XMPT, YYY, ZF, ZTR
by: Stanford Chemist

Summary

Average premium/discounts and z-scores recover modestly this month.

Equity CEFs more expensive than fixed income CEFs for the 4th month in a row, and the spread continues to widen.

Picks for this month are GRF, HYB, and FSD.

For the inaugural issue of The Chemist's CEF Report (September 2016), describing the background and rationale of the Report, please click here.

This edition uses data taken from the close of April 30. Previous editions of the Report can be searched using the keyword "cefrep." Cambridge Income Laboratory subscribers received this report about 1 month ago.

Methodology

A database of CEFs was obtained from CEFConnect. All yields are quoted as the yield on price. All z-scores refer to the 1-year z-score, which I consider to be the most useful time duration for profiting from premium/discount reversion. The 1-year z-score is calculated as the difference between the current premium/discount and the 1-year average premium/discount, all divided by the standard deviation of said premium/discount.

Positive z-scores indicate that the CEF's current premium/discount is higher than its historical average, while negative z-scores indicate that the current premium/discount is lower than the historical average. Incorporating the standard deviation into the z-score calculation enables comparison between CEFs that may have different magnitudes of absolute premia and discounts.

In the tables, "distance" refers to the distance between the current premium/discount of the fund and its 1-year historical premium/discount. "Coverage" refers to the ratio between a fund's earnings and its distribution, with coverage ratios greater than 100% indicating that the fund is earning more than it pays out in distributions.

Key to table headings:

P/D = premium/discount

Z = 1-year z-score

Dis = distance

Lev = leverage

BE = baseline expense

Cov = coverage

Note: I've renamed "debt" as "fixed income," as CEFs in this broad category invest not only in ordinary bonds but also loans, CLOs, preferred stock, etc.

1. Top 10 highest premia and top 10 highest discounts

(May interest arbitrage investors)

CEFs with the highest discounts are potential buy candidates, while CEFs with the highest premia are potential sell/short candidates. The following data show the 10 CEFs with the highest premia and 10 CEFs with the highest discounts. Yields, z-scores and leverage are shown for comparison.

Top 10 highest premia (equity):

CEF

Category

P/D

Y

Z

Dis

Lev

BE

Cov

(CRF)

US Equity-General Equity

25.1%

17.83%

1.2

7.4%

0.0%

1.22%

2%

(CLM)

US Equity-General Equity

22.1%

18.23%

1.2

6.6%

0.0%

1.20%

1%

(DNP)

US Equity-Growth & Income

20.4%

7.14%

3.0

7.0%

25.9%

1.00%

26%

(GUT)

US Equity-Utilities

17.6%

10.22%

-1.8

-12.3%

29.9%

1.23%

-5%

(SPXX)

US Equity-Covered Call

13.7%

6.12%

2.4

12.1%

0.0%

0.92%

6%

(QQQX)

US Equity-Covered Call

12.0%

6.59%

2.4

8.2%

0.0%

0.94%

1%

(GCV)

US Equity-Growth & Income

11.7%

7.74%

2.1

11.6%

23.8%

1.46%

-3%

(FPL)

US Equity-MLP

9.6%

11.39%

2.5

6.9%

24.5%

1.57%

0%

(NTG)

US Equity-MLP

9.6%

9.43%

2.3

6.7%

33.2%

1.75%

0%

(TYG)

US Equity-MLP

8.9%

9.37%

0.5

1.6%

33.3%

1.86%

0%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855722365599.png

Top 10 highest discounts (equity):

CEF

Category

P/D

Y

Z

Dis

Lev

BE

Cov

(OTCPK:FXBY)

US Equity-General Equity

-28.4%

0.47%

0.9

1.8%

0.0%

2.62%

#DIV/0!

(DNI)

US Equity-Growth & Income

-19.9%

4.81%

-1.2

-1.7%

0.0%

1.77%

9%

(RIF)

US Equity-Real Estate (US)

-18.5%

7.87%

-0.7

-1.1%

28.0%

1.83%

3%

(CET)

US Equity-General Equity

-17.3%

3.68%

-0.5

-0.4%

0.0%

0.75%

3%

(EGIF)

Non-US/Other-Global Growth & Income

-17.2%

5.71%

-1.5

-2.9%

24.3%

2.23%

71%

(GRF)

US Equity-General Equity

-16.4%

6.86%

-1.9

-4.2%

0.0%

1.22%

1%

(GDL)

Non-US/Other-Global Equity

-16.3%

4.27%

-0.9

-1.6%

38.0%

1.75%

-20%

(GRX)

US Equity-Health/Biotech

-16.0%

5.37%

-2.2

-3.5%

22.0%

1.25%

-15%

(PEO)

US Equity-Energy/Resources

-15.4%

2.54%

-1.2

-1.1%

0.7%

0.78%

43%

(GAM)

US Equity-General Equity

-15.3%

2.88%

0.4

0.2%

14.9%

1.32%

11%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855723946402.png

Top 10 highest premia (fixed income):

CEF

Category

P/D

Y

Z

Dis

Lev

BE

Cov

(RCS)

Non-US/Other-Global Income

26.0%

9.27%

0.4

2.3%

63.8%

0.98%

92%

(PGP)

Taxable Income-Multi-Sector

23.2%

10.91%

-1.2

-20.5%

31.9%

1.89%

79%

(PHK)

Taxable Income-Multi-Sector

21.0%

12.20%

0.3

2.2%

23.6%

0.96%

65%

(PTY)

Taxable Income-Investment Grade

18.8%

8.91%

3.7

6.9%

29.6%

0.86%

77%

(DMO)

Taxable Income-Mortgage Bond

17.0%

10.69%

-0.2

-0.6%

31.1%

1.76%

15%

(PCN)

Taxable Income-Investment Grade

14.4%

7.92%

1.2

2.4%

22.4%

1.01%

86%

(PCM)

Taxable Income-Mortgage Bond

12.9%

8.31%

1.0

3.0%

38.5%

1.55%

93%

(PCQ)

Tax-Free Income-California

9.9%

6.23%

-1.6

-7.9%

46.5%

1.16%

117%

(ECC)

Taxable Income-Senior Loan

8.8%

12.95%

-0.8

-5.2%

31.4%

3.29%

74%

(EDF)

Non-US/Other-Emerging Market Income

8.3%

14.35%

-0.5

-1.4%

31.7%

1.85%

66%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855725389404.png

Top 10 highest discounts (fixed income):

CEF

Category

P/D

Y

Z

Dis

Lev

BE

Cov

(NUM)

Tax-Free Income-Michigan

-15.1%

4.25%

-1.5

-2.5%

38.4%

0.99%

108%

(EDD)

Non-US/Other-Emerging Market Income

-15.1%

7.95%

-1.7

-3.5%

31.8%

1.75%

38%

(EVJ)

Tax-Free Income-New Jersey

-15.0%

4.88%

-1.1

-2.3%

37.8%

1.54%

106%

(NXJ)

Tax-Free Income-New Jersey

-15.0%

5.37%

-1.4

-1.8%

39.1%

1.01%

98%

(NQP)

Tax-Free Income-Pennsylvania

-15.0%

5.16%

-1.6

-2.6%

40.6%

0.95%

103%

(MNE)

Tax-Free Income-New York

-15.0%

3.81%

-2.1

-3.9%

37.6%

1.23%

109%

(NNC)

Tax-Free Income-North Carolina

-14.8%

3.86%

-1.7

-2.8%

39.4%

1.04%

105%

(NUO)

Tax-Free Income-Ohio

-14.7%

4.27%

-1.8

-3.6%

38.7%

1.04%

107%

(CEV)

Tax-Free Income-California

-14.5%

3.90%

-1.3

-2.5%

35.9%

1.44%

107%

(FT)

Taxable Income-Multi-Sector

-14.5%

5.70%

-2.3

-2.2%

22.8%

1.12%

101%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-1525085572583092.png

2. Top 10 highest z-scores and top 10 lowest z-scores

(May interest arbitrage investors)

Similar to premia/discounts, CEFs with the lowest z-scores are potential buy candidates, while CEFs with the highest z-scores are potential sell/short candidates. The following data show the 10 CEFs with the highest z-scores and 10 CEFs with the lowest z-scores. Premium/discount, yields and leverage are shown for comparison.

Top 10 highest z-scores (equity):

CEF

Category

Z

P/D

Y

Dis

Lev

BE

Cov

(DIAX)

US Equity-Covered Call

3.6

1.2%

6.7%

5.6%

0.0%

0.93%

7%

(EOI)

US Equity-Covered Call

3.6

0.7%

6.9%

5.2%

0.0%

1.11%

11%

(RVT)

US Equity-General Equity

3.5

-4.8%

7.1%

4.6%

4.9%

0.54%

5%

(DDF)

US Equity-Growth & Income

3.2

-5.9%

10.8%

3.2%

30.3%

1.14%

27%

(DNP)

US Equity-Growth & Income

3.0

20.4%

7.1%

7.0%

25.9%

1.00%

26%

(EOS)

US Equity-Covered Call

3.0

2.2%

6.4%

4.4%

0.0%

1.10%

-3%

(CEN)

US Equity-MLP

2.9

6.9%

13.3%

5.4%

34.6%

2.04%

0%

(MIE)

US Equity-MLP

2.6

-1.0%

9.2%

5.1%

25.1%

1.72%

0%

(IF)

Non-US/Other-Asia Equity

2.6

-5.7%

0.7%

3.0%

0.0%

1.62%

-14%

(FPL)

US Equity-MLP

2.5

9.6%

11.4%

6.9%

24.5%

1.57%

0%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855726214814.png

Top 10 lowest z-scores (equity):

CEF

Category

Z

P/D

Y

Dis

Lev

BE

Cov

(GRX)

US Equity-Health/Biotech

-2.2

-16.0%

5.4%

-3.5%

22.0%

1.25%

-15%

(JRS)

US Equity-Real Estate (US)

-2.2

-5.5%

9.5%

-3.6%

30.3%

1.35%

18%

(TWN)

Non-US/Other-Asia Equity

-2.0

-13.0%

3.4%

-1.7%

0.0%

1.80%

-4%

(FDEU)

Non-US/Other-Other Non-US Equity

-2.0

-6.9%

8.2%

-3.0%

24.7%

1.60%

11%

(GRF)

US Equity-General Equity

-1.9

-16.4%

6.9%

-4.2%

0.0%

1.22%

1%

(BUI)

US Equity-Utilities

-1.9

-3.3%

7.3%

-2.8%

0.0%

1.09%

35%

(HTD)

US Equity-Equity Tax-Advantaged

-1.8

-8.5%

7.5%

-4.5%

31.6%

1.20%

108%

(GUT)

US Equity-Utilities

-1.8

17.6%

10.2%

-12.3%

29.9%

1.23%

-5%

(LDF)

Non-US/Other-Latin American Equity

-1.8

-13.4%

0.4%

-1.3%

0.0%

1.55%

22%

(HQH)

US Equity-Health/Biotech

-1.6

-8.6%

9.0%

-4.2%

0.0%

1.10%

-2%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-1525085572708024.png

Top 10 highest z-scores (fixed income):

CEF

Category

Z

P/D

Y

Dis

Lev

BE

Cov

(CHY)

Taxable Income-Multi-Sector

3.8

4.6%

9.9%

4.2%

32.2%

1.23%

49%

(PTY)

Taxable Income-Investment Grade

3.7

18.8%

8.9%

6.9%

29.6%

0.86%

77%

(PCF)

Taxable Income-High Yield

2.8

-4.9%

3.7%

2.1%

0.0%

1.19%

81%

(KST)

Non-US/Other-Global Income

2.3

-2.8%

4.3%

1.6%

26.1%

0.00%

110%

(TEI)

Non-US/Other-Emerging Market Income

2.2

-7.5%

9.0%

3.4%

0.0%

1.08%

28%

(ACV)

Taxable Income-Multi-Sector

2.0

-0.4%

8.8%

3.6%

30.0%

1.66%

10%

(PFL)

Taxable Income-Multi-Sector

1.9

6.3%

9.1%

3.1%

24.1%

1.13%

78%

(OXLC)

Taxable Income-Senior Loan

1.9

6.8%

15.1%

3.2%

38.2%

7.93%

99%

(ICB)

Taxable Income-Investment Grade

1.8

-1.0%

2.8%

4.2%

0.0%

0.68%

116%

(HFRO)

Taxable Income-Senior Loan

1.7

5.4%

5.8%

3.8%

0.0%

1.47%

0%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855727975974.png

Top 10 lowest z-scores (fixed income):

CEF

Category

Z

P/D

Y

Dis

Lev

BE

Cov

(FMY)

Taxable Income-Mortgage Bond

-3.9

-11.3%

5.4%

-2.9%

7.1%

1.20%

47%

(NAZ)

Tax-Free Income-Arizona

-2.9

-7.6%

4.1%

-6.6%

37.2%

1.03%

107%

(MVT)

Tax-Free Income-National

-2.6

-4.6%

5.4%

-6.1%

38.4%

0.91%

106%

(JMM)

Taxable Income-Mortgage Bond

-2.6

-11.1%

5.1%

-3.2%

19.5%

1.47%

101%

(MVF)

Tax-Free Income-National

-2.6

-7.1%

5.7%

-6.4%

37.9%

0.90%

105%

(MFL)

Tax-Free Income-National

-2.4

-9.5%

5.3%

-8.5%

41.3%

1.04%

107%

(NMZ)

Tax-Free Income-High Yield

-2.4

-5.8%

5.8%

-5.6%

38.6%

1.06%

107%

(DHY)

Taxable Income-High Yield

-2.4

-3.0%

9.2%

-3.8%

31.5%

1.52%

94%

(NBW)

Tax-Free Income-California

-2.4

-14.3%

4.3%

-5.7%

41.4%

1.28%

109%

(MIY)

Tax-Free Income-Michigan

-2.3

-12.7%

5.3%

-2.8%

38.8%

0.87%

101%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855728735814.png

3. Top 10 highest yielding CEFs

(May interest buy-and-hold income investors)

Some readers are mostly interested in obtaining income from their CEFs, so the following data presents the top 10 highest yielding CEFs. I've also included the premium/discount and z-score data for reference. Before going out and buying all 10 funds from the list, some words of caution: [i] higher yields generally indicate higher risk, [ii] some of these funds trade at a premium, meaning you will be buying them at a price higher than the intrinsic value of the assets (which is why I've included the premium/discount and z-score data for consideration), and [iii] beware of funds paying out high yields from return of capital in a destructive manner.

Top 10 highest yields (equity):

CEF

Category

Y

P/D

Z

Dis

Lev

BE

Cov

(GRR)

Non-US/Other-Asia Equity

22.7%

-6.5%

0.5

1.0%

0.0%

2.52%

0%

(CLM)

US Equity-General Equity

18.2%

22.1%

1.2

6.6%

0.0%

1.20%

1%

(CRF)

US Equity-General Equity

17.8%

25.1%

1.2

7.4%

0.0%

1.22%

2%

(DSE)

US Equity-MLP

15.0%

7.7%

1.2

4.2%

36.0%

2.08%

0%

(NDP)

US Equity-MLP

14.2%

-0.1%

-0.6

-2.2%

24.6%

1.68%

0%

(CEN)

US Equity-MLP

13.3%

6.9%

2.9

5.4%

34.6%

2.04%

0%

(ZF)

Non-US/Other-Global Growth & Income

13.1%

-2.2%

1.5

3.7%

25.6%

1.92%

10%

(ZTR)

US Equity-Growth & Income

12.5%

-2.9%

-1.2

-4.2%

27.7%

1.43%

23%

(GCH)

Non-US/Other-Asia Equity

12.5%

-4.4%

2.2

3.8%

0.0%

1.78%

0%

(RIV)

US Equity-Growth & Income

12.0%

8.6%

2.0

7.5%

0.0%

1.76%

-51%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855732203124.png

Top 10 highest yields (fixed income):

CEF

Category

Y

P/D

Z

Dis

Lev

BE

Cov

(OXLC)

Taxable Income-Senior Loan

15.1%

6.8%

1.9

3.2%

38.2%

7.93%

99%

(EDF)

Non-US/Other-Emerging Market Income

14.4%

8.3%

-0.5

-1.4%

31.7%

1.85%

66%

(ECC)

Taxable Income-Senior Loan

13.0%

8.8%

-0.8

-5.2%

31.4%

3.29%

74%

(EDI)

Non-US/Other-Emerging Market Income

12.5%

-0.9%

-0.9

-2.8%

32.1%

1.96%

80%

(VGI)

Taxable Income-Multi-Sector

12.4%

2.4%

0.5

1.7%

26.1%

1.75%

46%

(PHK)

Taxable Income-Multi-Sector

12.2%

21.0%

0.3

2.2%

23.6%

0.96%

65%

(EXD)

Taxable Income-Government

11.9%

-6.8%

0.5

1.0%

0.0%

1.45%

3%

(NCZ)

Taxable Income-Multi-Sector

11.6%

4.9%

0.9

1.1%

38.2%

1.37%

89%

(NCV)

Taxable Income-Multi-Sector

11.5%

7.4%

1.4

2.0%

37.9%

1.32%

88%

(FTF)

Taxable Income-Limited Duration

11.0%

-6.0%

0.1

0.1%

24.0%

1.20%

32%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-1525085572937706.png

4. Top 10 best combination of yield and discount

(May interest buy-and-hold income investors)

For possible buy candidates, it is probably a good idea to consider both yield and discount. Buying a CEF with both a high yield and discount not only gives you the opportunity to capitalize from discount contraction, but you also get "free" alpha every time the distribution is paid out. This is because paying out a distribution is effectively the same as liquidating the fund at NAV and returning the capital to the unitholders. I considered several ways to rank CEFs by a composite metric of both yield and discount.

The simplest would be yield + discount, however I disregarded this because yields and discounts may have different ranges of absolute values and a sum would be biased towards the larger set of values. I finally settled on the multiplicative product, yield x discount.

This is because I consider a CEF with 7% yield and 7% discount to be more desirable than a fund with 2% yield and 12% discount, or 12% yield and 2% discount, even though each pair of quantities sum to 14%. Multiplying yield and discount together biases towards funds with both high yield and discount. Since discount is negative and yield is positive, the more negative the "D x Y" metric, the better.

Top 10 best D x Y (equity):

CEF

Category

P/D

Y

Z

D x Y

Dis

Lev

BE

Cov

(GRR)

Non-US/Other-Asia Equity

-6.5%

22.7%

0.5

-1.48

1.0%

0.0%

2.52%

0%

(RIF)

US Equity-Real Estate (US)

-18.5%

7.9%

-0.7

-1.45

-1.1%

28.0%

1.83%

3%

(IRL)

Non-US/Other-Other Non-US Equity

-15.0%

9.6%

-0.9

-1.44

-2.8%

0.0%

0.00%

-6%

(LCM)

Non-US/Other-Global Growth & Income

-11.1%

10.6%

-1.3

-1.17

-2.3%

28.0%

0.49%

6%

(TDF)

Non-US/Other-Asia Equity

-13.6%

8.6%

-1.4

-1.16

-1.7%

0.0%

1.35%

1%

(DPG)

US Equity-Utilities

-11.7%

9.8%

-1.5

-1.15

-1.7%

28.1%

1.53%

13%

(GRF)

US Equity-General Equity

-16.4%

6.9%

-1.9

-1.13

-4.2%

0.0%

1.22%

1%

(INF)

Non-US/Other-Global Equity

-13.2%

8.0%

-1.2

-1.05

-1.6%

27.4%

1.89%

-2%

(GLO)

Non-US/Other-Global Growth & Income

-8.9%

11.5%

-0.2

-1.02

-0.5%

36.8%

2.27%

-3%

(IGR)

US Equity-Real Estate (Global)

-12.4%

8.1%

-0.4

-1.01

-0.4%

13.1%

1.16%

35%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855731719923.png

Top 10 best D x Y (fixed income):

CEF

Category

P/D

Y

Z

D x Y

Dis

Lev

BE

Cov

(EDD)

Non-US/Other-Emerging Market Income

-15.1%

8.0%

-1.7

-1.20

-3.5%

31.8%

1.75%

38%

(EMD)

Non-US/Other-Emerging Market Income

-13.5%

8.4%

-1.4

-1.14

-1.4%

21.7%

1.21%

99%

(AGC)

Taxable Income-Convertible

-11.2%

10.0%

-1.2

-1.12

-2.5%

40.9%

2.09%

38%

(FHY)

Taxable Income-High Yield

-13.5%

8.0%

-1.4

-1.07

-3.8%

26.7%

1.24%

74%

(FSD)

Taxable Income-High Yield

-12.8%

8.4%

-2.1

-1.07

-5.0%

19.8%

1.18%

78%

(GHY)

Taxable Income-High Yield

-14.4%

7.2%

-1.8

-1.03

-3.4%

27.2%

1.25%

76%

(ISD)

Taxable Income-High Yield

-14.1%

7.3%

-2.3

-1.03

-4.0%

24.3%

1.00%

72%

(AVK)

Taxable Income-Convertible

-10.8%

9.3%

-1.2

-1.01

-2.3%

39.1%

1.14%

49%

(FAM)

Non-US/Other-Global Income

-12.3%

8.2%

-1.2

-1.01

-2.3%

27.4%

1.84%

86%

(FAX)

Non-US/Other-Global Income

-10.9%

9.2%

-1.3

-1.00

-2.0%

29.5%

1.14%

52%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855731659446.png

5. Top 10 best combination of yield, discount and z-score

(May interest buy-and-hold income investors + arbitrage investors)

This is my favorite metric because it takes into account all three factors that I always consider when buying or selling CEFs: yield, discount and z-score. The composite metric simply multiplies the three quantities together. A screen is applied to only include CEFs with a negative 1-year z-score. As both discount and z-score are negative while yield is positive, the more positive the "D x Y x Z" metric, the better.

Top 10 best D x Y x Z (equity):

CEF

Category

P/D

Y

Z

D x Y x Z

Dis

Lev

BE

Cov

(GRF)

US Equity-General Equity

-16.4%

6.9%

-1.9

2.14

-4.2%

0.0%

1.22%

1%

(GRX)

US Equity-Health/Biotech

-16.0%

5.4%

-2.2

1.89

-3.5%

22.0%

1.25%

-15%

(DPG)

US Equity-Utilities

-11.7%

9.8%

-1.5

1.73

-1.7%

28.1%

1.53%

13%

(TDF)

Non-US/Other-Asia Equity

-13.6%

8.6%

-1.4

1.63

-1.7%

0.0%

1.35%

1%

(RNP)

US Equity-Real Estate (US)

-12.1%

8.0%

-1.6

1.55

-2.9%

24.4%

1.01%

67%

(LCM)

Non-US/Other-Global Growth & Income

-11.1%

10.6%

-1.3

1.52

-2.3%

28.0%

0.49%

6%

(EGIF)

Non-US/Other-Global Growth & Income

-17.2%

5.7%

-1.5

1.47

-2.9%

24.3%

2.23%

71%

(JRI)

US Equity-Real Estate (Global)

-12.1%

7.8%

-1.4

1.32

-2.5%

30.5%

1.84%

90%

(MCN)

US Equity-Covered Call

-9.0%

9.8%

-1.5

1.32

-2.4%

0.0%

0.87%

8%

(IRL)

Non-US/Other-Other Non-US Equity

-15.0%

9.6%

-0.9

1.30

-2.8%

0.0%

0.00%

-6%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-15250855732420187.png

Top 10 best D x Y x Z (fixed income):

CEF

Category

P/D

Y

Z

D x Y x Z

Dis

Lev

BE

Cov

(FMY)

Taxable Income-Mortgage Bond

-11.3%

5.4%

-3.9

2.36

-2.9%

7.1%

1.20%

47%

(ISD)

Taxable Income-High Yield

-14.1%

7.3%

-2.3

2.36

-4.0%

24.3%

1.00%

72%

(FSD)

Taxable Income-High Yield

-12.8%

8.4%

-2.1

2.25

-5.0%

19.8%

1.18%

78%

(EDD)

Non-US/Other-Emerging Market Income

-15.1%

8.0%

-1.7

2.04

-3.5%

31.8%

1.75%

38%

(FT)

Taxable Income-Multi-Sector

-14.5%

5.7%

-2.3

1.90

-2.2%

22.8%

1.12%

101%

(GHY)

Taxable Income-High Yield

-14.4%

7.2%

-1.8

1.85

-3.4%

27.2%

1.25%

76%

(NHS)

Taxable Income-High Yield

-13.8%

7.2%

-1.8

1.79

-2.4%

32.2%

1.24%

115%

(VLT)

Taxable Income-High Yield

-12.7%

7.3%

-1.9

1.77

-2.7%

26.4%

1.12%

101%

(HYB)

Taxable Income-High Yield

-12.7%

7.6%

-1.8

1.74

-4.9%

27.5%

1.14%

105%

(AWF)

Taxable Income-High Yield

-12.6%

7.1%

-1.9

1.70

-3.5%

4.7%

0.99%

100%

https://static.seekingalpha.com/uploads/2018/4/30/49181399-1525085573289452.png

6. Summary statistics

The average premium/discount of all the CEFs in the database is -6.02%, a moderate increase from -6.33% in the previous month. The increase in average premium/discount was driven by an increase in equity CEF valuations, which saw discounts contract from -5.64% last month to -4.97% (67 bps increase). In contrast, fixed income CEFs saw discounts contract by only 12 bps, from -6.73% to -6.61%.

The average distribution yield of all the CEFs in the database is 6.78%, a slight increase from 6.77% in the month prior. Equity CEFs average 7.88% yield, while fixed income CEFs average 6.15% yield.

The average 1-year z-score of all the CEFs in the database is -0.54, a substantial increase from -0.92 a month ago. Equity CEFs have an average z-score of +0.25, while fixed income CEFs have an average z-score of -0.98.

Commentary

In last month's commentary "The Chemist's CEF Report - April 2018: CEF Discounts Widen To 12-Month Lows," we noted that CEF discounts widened to 12-month lows (lowest since January 2017).

CEF valuations recovered somewhat this month. Average discounts narrowed from -6.33% to -6.02%, driven primarily by a 67 bps contraction in the average equity discount (from -5.65% to -4.97%). In contrast, fixed income CEFs saw discounts contract by only 12 bps. Average premium/discount was driven by an increase in equity CEF valuations, which saw discounts contract from -5.64% last month to -4.97% (67 bps increase). In contrast, fixed income CEFs saw discounts contract by only 12 bps (from -6.73% to -6.61%).

The net effect of this was to see the spread between equity and fixed income CEF valuations continue to widen, from 1.10% last month to 1.64% this month. It was only 9 short months ago when fixed income CEFs were more expensive than equity CEFs by 3.16%!

The obvious reason for this reversal of valuations is rising rates, which negatively impacts fixed income CEFs much more than equity CEFs. As we can see from the chart, rates across the maturity spectrum have risen steadily over the past year.

Chart

3-Month LIBOR based on US Dollar data by YCharts

Short rates have risen more quickly than long rates, causing a flattening of the yield curve. For example, the well-known 10-2 spread has reached a new post-recession low this month, hitting 0.41% on April 17.

Chart

10-2 Year Treasury Yield Spread data by YCharts

Yield curve flattening is a negative particularly for leveraged fixed income CEFs that borrow at the short rate and lend at the long rate. Of the different fixed income sectors, muni CEFs have been hit especially hard due to their long durations and low starting yields.

We can see the effect on muni CEFs quite easily when comparing the VanEck Vectors CEF Municipal Income ETF (NYSEARCA:XMPT), an ETF-of-muni CEFs, with the iShares National Bond ETF (MUB), the straight ETF benchmark. We can see an accelerated selloff of XMPT starting in the middle of January, causing the YTD return of XMPT to crater to -6.16% (due to widening of constituent muni CEF discounts) even while the benchmark ETF has fallen by "only" -2.66%.

Chart

XMPT data by YCharts

Are muni CEFs attractively priced now or is there further pain ahead? The Closed-End Fund Association has a recent transcript of an interview "Munis: Implications And Opportunities Amid Changing Reform And Legislation" posted on Seeking Alpha where Purva Patel, senior vice-president and client portfolio manager at Nuveen Asset Management, answers the question as to whether rising rates have already been baked into fixed income prices.

Libby Hastert: Great. Now, Purva, with these Fed-tightening cycles, would you say that some of this is already priced in at this point?

Purva Patel: It's tough to say that with 100% certainty. But, I think what we have seen as the Fed has tightened, is that the short end of the curve is very sensitive to what the Fed is doing. Whereas the long end of the curve and Robert mentioned this, the long end of the curve in 2004 to 2006 did something opposite of what investors had expected. I think you may experience something similar to that with this market and just as we experience the next few Fed rate increases. It's tough to make a case for the 10-year treasury and the 30-year treasury to be at significantly higher levels than what they are right now without a lot of inflation.

With that said, we think maybe a lot of the pricing in, if you will, the Fed rate raises may have already been priced into the market on the intermediate and the long part of the curve, but the short part of the curve will still probably see some sensitivity to what the Fed does for the rest of the year.

The short answer is that no one really knows for sure (and economists often get rate predictions wrong!). Where I do agree with Purva Patel is that fixed income can still play a valuable role in smoothing returns and lowering volatility of an equity-heavy portfolio, especially for investors in the high-income bracket.

Libby Hastert: I'm interested, Purva, from the portfolio management perspective, is this affecting your outlook on muni bonds as a sound long-term portfolio investment?

Purva Patel: No, not at all. Actually, I think, taking it back to the investor, too, is that the investor doesn't feel that either. We have seen over $10 billion go into municipal mutual funds as an industry, so that tells me that investors are still seeking out municipal investments as part of their overall portfolio. Volatility has dropped in the race market in the near past. I think a lot of it has to do, too, with the fact that volatility has picked up in the equity markets. That's pointing investors in the direction of fixed income as, perhaps, a bigger allocation or a new allocation to their overall portfolios. We think, as a long-term investment strategy, as well as part of an overall asset allocation for an individual investor, municipal bonds still make a lot of sense.

We ran a study that looks at municipal investments as part of an overall allocation of funds and equities. We found that municipals reduce the volatility of an all-equity portfolio by a third, as well as give you about the same total return as an all-equity portfolio. With those kinds of risk-reducing benefits, it still does make a lot of sense to own municipal bonds.

My comments last month about fixed income CEFs being more attractively valued than equity CEFs still remain relevant. For investors who are interested in exploiting CEF rotation, I would recommend looking through your equity CEF holdings and considering whether any can be substituted or replaced with a cheaper CEF or ETF alternative (as we just did in the Income Generator portfolio, swapping EOI for BDJ).

Turning now to the broader markets, we can see that the fear of rising rates has hit long-dated treasuries (NYSEARCA:TLT) (-2.24% in April) and corporate bonds (NYSEARCA:LQD) (-1.57%) hard. Stocks were modestly positive, with international stocks (NASDAQ:ACWX) (+0.56%) slightly edging U.S. stocks (SPY) (+0.43%). Junk bonds (JNK) rose +0.45%, while a basket of high-yield CEFs (YYY) was the unexpected leader at +1.07%.

Chart I intend to give a list of my top 3 CEF picks each month, which is based on my consideration of the data as well as my qualitative judgment. Note that me designating a fund as a top pick does not mean I am encouraging subscribers to buy the fund, nor am I necessarily going to include the fund in our portfolios.

Moreover, note that some of the picks may have a narrow mandate (e.g. utilities stocks or MLPs), and therefore each investor should consider their own investment objective and risk tolerance before deciding to invest money into any of the picks. Furthermore, note that these are intended to be short/medium-term picks (to take advantage of mean reversion) rather than long-term holds.

For May 2018, my top 3 picks are:

  • Eagle Capital Growth Fund (GRF): 6.9% yield, -16.4% discount, -1.9 z-score, -4.2% distance, 0% leverage, 1.22% baseline expense, 1% coverage.
  • New America High Income Fund (HYB): 7.2% yield, -12.7% discount, -1.8 z-score, -4.9% distance, 27.5% leverage, 1.14% baseline expense, 105% coverage.
  • First Trust High Income Long/Short Fund (FSD): 8.4% yield, -12.8% discount, -3.0 z-score, -5.5% distance, 19.8% leverage, 1.18% baseline expense, 78% coverage.

GRF was the highest D x Y x Z fund among the equity CEFs. It is a U.S. general equity fund, but looking at the top holdings below shows that it's definitely not a clone of the S&P 500. This fund appears to run a very concentrated portfolio, with over two-thirds of the fund concentrated within the top 10 names, including a massive 15.50% (!) position in Colgate-Palmolive (CL) (which unfortunately is making fresh 52-week lows). It also does not have any of the FAANG stocks in its top holdings.

Remember, the monthly picks aim to take advantage of mean reversion, and in the case of GRF capture the ~4% difference between the current discount of -16.4% and the 1-year average discount of -12.3%. For a long-term holding, I would be conducting much more due diligence on the management and past performance of the fund. Also, GRF pays an annual dividend in December of each year, so we would not expect to receive any distributions during our 3 month holding period.

The second pick is the high-yield CEF HYB, which ranked 9th in the fixed income D x Y x Z list. Its current discount of -12.7% is -4.9% wider than its 1-year average discount, and the 1-year z-score is -1.8. It did cut its distribution by -8% in January of this year (from 6 cents to 5.5 cents monthly), which could have been a contributing factor to its relatively low valuation. Its current coverage is 105% suggesting that the distribution is safe for the time being. It yields 7.6%.

The third pick is another high-yield CEF, FSD, which ranked 3rd in the fixed income D x Y x Z list. It's trading at a -12.8% discount, which is around -5.0% wider than its 1-year average discount. FSD was also picked last month, and my rationale for the pick remains the same.

This fund experienced a recent distribution cut of -18% as its standstill agreement with Saba Capital Management expired, as detailed in "Weekly CEF Roundup: Kayne Anderson Roll-Up And Legal Victory For HFRO/NHF". The premium/discount predictably collapsed soon afterwards, opening up the possibility of mean reversion as the negative sentiment wanes.

For past performance of picks, see "Reflections On Chemist's CEF Report Pick Performance In 2017." Past performance is no guarantee of future results.

Disclosure: I am/we are long THE PORTFOLIO SECURITIES.

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.