CEF Report May 2019: Distribution Cuts Subside

by: Alpha Gen Capital

Distribution cuts subsided in the month with the largest being *just* 8%.

We run through some April CEF stats.

We provide some high-level commentary.

We finished the April reporting season for distribution cuts with a relatively benign day. In fact, we saw more distribution increases than decreases for the first time in a long while. Nine funds increased the payout by an average of 3.4% while the 8 cuts averaged 4.6%.

Overall, the valuations across the CEF universe continue to tighten, though the rate of change has slowed and even reversed in the last couple of weeks of April. In the fixed income side of the CEF space, average discounts are now just over -6% which is roughly an average long-term valuation. Equity CEFs are very close to the same levels.

From CEFA:

What does this mean for valuations and where are we focusing our efforts?

We are constantly looking at a lot of the macro data to see where investors are placing their capital. Closed-end funds are probably the ultimate sentiment indicators given the large retail presence. As contrarian investors, we often take the other side of those sectors shifts. In addition, we are often buying when others are selling and selling when the trend has been buying.

It now has been over four months since the last big buying opportunity. That doesn't mean there haven't been sector specific or fund specific opportunities since then. It does mean, however, that our overall trend has been to hold and collect income while trimming back as some funds get overheated.

The chart below from CEFAdvisors' quarterly CEF webinar shows the long-term valuation of the taxable CEF space. The fourth quarter was one of only a handful of times over the last 20 years where discounts were as wide as they were. The time before that was one of the widest in history and the impetus for us starting our CEF marketplace service back in early 2016. Through the first quarter, we are very close to long-term average discounts on taxable bonds. In fact, our Core Portfolio currently has only 3 of the 13 positions rated as "buy."

In the first quarter, according to data by Closed-End Fund Advisors, we saw 72 distribution increases and 98 distribution decreases. That represents +5.7% and -7.8% of funds, respectively. The average change for the increases was +5.4% and the average decline at -8.4%. There is a 4 to 1 ratio of cuts to increases over the last three years. But more recently, it appears that the ratio may be evening out a bit. That may have to do with the cessation of lower rates making coupon replacement a bit easier.

It remains to be seen if we are currently seeing an end to the trend of deep cuts to distributions like we've experienced over the last ten years. UNIIs, while still falling, are seeing a slower rate of change. In addition, once we pass 2019, which is ten years beyond a large amount of issuance on the muni side in 2009 (munis are typically call eligible at the ten-year mark), we could see a reduced amount of calls affecting muni CEFs. The next largest amount of high coupon issuance was around the Taper Tantrum of 2013 which would give us a reprieve of sorts until 2023 (dependent on the movement of rates between now and then).

Let's go through the cuts and bumps.

Distribution Increases (>2%)

Eaton Vance Short Duration Diversified Income Fund (EVG): Increase by 15.4% from $0.065 to $0.075

Templeton Global Income Fund (GIM): Increase by 5.4% from $0.0336 to $0.0354

Eaton Vance Limited Duration Income Fund (EVV): Increase by 4.5% from $0.067 to $0.07

Distribution Decreases (>2%)

Invesco Pennsylvania Value Municipal Income Trust (VPV): Cut by 7.76% from $0.058 to $0.0535

MFS High Yield Municipal Trust (CMU): Cut by 5.0% from $0.02 to $0.019

Templeton Emerging Markets Income Fund (TEI): Cut by 4.6% from $0.0701 to $0.0669

MFS High Income Municipal Trust (CXE): Cut by 4.5% from $0.022 to $0.021

MFS California Municipal Fund (CCA): Cut by 4.3% from $0.035 to $0.0335.

MFS Investment Grade Municipal Trust (CXH): Cut by 4.1% from $0.037 to $0.0355

MFS Municipal Income Trust (MFM): Cut by 3.5% from $0.029 to $0.028

Invesco Bond Fund (VBF): Cut by 2.9% from $0.07 to $0.068


The strongest sector on the bond side was leveraged loans (floating rate) which reversed course from its weak March posting and rose 2.87%. The NAV was up +1.40%. Preferreds were the second best taxable income sector rising +2.17% on price and +1.50% on NAV. It was followed by convertibles (+2.07% price, 2.21% NAV) and high yield (+2.03% on price, +1.25% NAV).

Munis had a very strong month and have had a very strong 2019. In April, munis rose +0.40% on price and +0.88% on NAV. In fact, muni z-scores are now some of the most expensive with single state muni CEFs averaging +1.23.

According to Lipper, 89% of all CEFs were positive in the month of April including 95% of bond CEFs and 78% of equity-oriented CEFs. Equity CEFs posted a positive return of +1.40% in April while fixed income CEFs saw a +1.01% on NAV. This is the fourth month in a row that both sides of the CEF market have realized positive results.

We participated in one of the corporate actions in the month with the small 5% tender in BlackRock Debt Strategies Fund (NYSE:DSU). Other corporate actions that remain ongoing include the approved liquidation of Alliance California Municipal Income Fund (AKP) which will close on May 2. Morgan Stanley Asia-Pacific Fund (APF) is being merged into one of their open-end funds. Eaton Vance Municipal Bond Fund (EIM) also conducted a 10% cash tender offer at 98% of NAV which expires on May 17th. Lastly, NexPoint Strategic Opportunities Fund (NHF) announced another rights offering last month which we wrote about recently (HERE)


Much greater color was provided in our member post...

This was another solid month for distribution stability. Last month, PIMCO made big news cutting the distribution on 8 of their funds with an average reduction of 15.25%. Each fund sponsor has a different take on distribution cuts. Some focus on distribution stability above all else. Others would rather have a variable distribution so that the small movements in the payment each month do not make a large scale difference. Here, you are competing on portfolio management expertise above anything else.

This month, the largest cutter was Invesco Pennsylvania Value Municipal Income Trust (VPV), a fund we first brought to members' attention early in 2018. We immediately issued a "cut alert" to members within minutes of the release, allowing people to get out before the market recognized it. What drove our interest into a state specific muni fund? Primarily, the large UNII bucket and high yield. For muni CEFs, that is the best combination of data points for screening. At the start of 2018, the fund had 12.7 cents of UNII and was paying a distribution yield of 5.57% with a portfolio mix of investment grade and non-investment grade.

Since the start of 2018, coverage slipped to the mid-80s late last year. At that coverage level, UNII can erode at a fairly quick pace. In the last four months, UNII has been falling by double digits. This is a big red flag for any muni CEF, especially when the UNII level is already negative. What is surprising is that they cut when there was still 6.8 cents of UNII left.

Unlike PIMCO, most of the other sponsors would rather make smaller moves over time rather than shock investors with a massive cut. The 7% cut on the March coverage ratio only moves it back to 93.1%. It is probable that UNII will continue to decline despite the cut, although at a slower pace. Another 7%-9% cut is likely down the road - perhaps in 6-9 months.

The muni space is one of the most compelling right now as the Fed being on hold removes a significant overhang, rising rates. We will be issuing our muni report shortly with some updates to existing holdings and a few new holdings.

Moving on to the MFS funds, which have a variable distribution rate that attempts to match payout with NII (net investment income), all five cut between 3% and 5% in May. This has been a trend over the last several months as the funds have trimmed every couple of months. For MFS High Income Municipal Trust, the total cut since September has been 12.5%. The yield fell from 5.10% to 4.86%. Even small moves can hit the yield significantly.

(Source: CEFConnect, AlphaGenCapital)

The discounts on the two primary funds (CXE and CMU) are still relatively tight, though off the 52-week highs of a few weeks ago. After the news, share fell by about 25 bps with CXE trading at $5.15, about 9 cents below the 52-week high set two weeks ago. Despite the cuts, CXE is up 13.9% YTD, substantially outpacing NAV which is up 4.45%. The fund is a great demonstration on what is happening in the muni space.

Concluding Thoughts

Avoiding distribution cuts while at the same time watching those funds that have recently cut is, by far, the best avenue to success when investing in the closed-end fund space. Often, investors sell and then ask questions later following a cut. This can create a great opportunity for investors who can discern which cuts are "one-and-done" versus the serial cutters.

We've used this example before but it's a great way to illustrate it. Doubleline Opportunistic Credit Fund (NYSE:DBL) cut its distribution back in December by a substantial 34%. Investors subsequently sold off the shares sending the discount to nearly 8% when it averages a 5% premium (a -13 point swing). From our December report:

The fund has been issuing a Form 19a, which is information that they must file with the SEC on the sources of the distribution paid. In the November 19a, just 66% of the distribution came from net investment income ("NII"). On December 3rd, they announced the December distribution which implied a cut of 34%. If you look at the 19a, which showed 34% of the distribution coming from ROC, the massive cut is not a surprise.

We will of course be watching the funds that cut their distributions recently for any opportunities that arise.

Disclosure: I am/we are long VPV, CXE, DBL. 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.