General market sentiment has become downright dour in the last month, but you wouldn't know it by looking at movements in CEF discounts. Typically, when we see market volatility and especially when we see high-yield spreads in the bond market widen, the double-edged sword that is closed-end fund discounts widens, sending pricing down faster than the NAVs. However, in the month of May, when the S&P 500 fell by more than 6%, discounts actually tightened by approximately 30 bps.
In our June letter, we advised members to hold steady as this could just be the beginning - at least on the CEF side of things. Recall back in the fourth quarter that CEFs initially weathered the slide well, but eventually saw a significant decline in December on the back of tax loss harvesting and another Fed rate increase. My fear is that this could happen again as fixed income CEFs particularly adjust their NAVs late compared to the very liquid pricing in the equity markets. The largely retail investor base is then likely to get out, presenting us with opportunity.
The chart below shows the CBOE Volatility Index (^VIX) and the discount/premium to NAV of Ivy High Income Opps (IVH), a fund we own in the Core Portfolio. You can clearly see the inverse relationship between the two data points over the last year.
The above chart is why we spend so much time on volatility - it is a great leading indicator to future near-term discounts in our view. We recently wrote a follow-up to an article we wrote several years ago about price risk in closed-end funds titled, "How To Measure Closed-End Fund Risk." The increased volatility in the equity tends to filter through to the bond market and eventually closed-end funds through wider discounts. While we view this as an opportunity - an occasion to put pooled cash to work - others tend to get scared and start selling, often at just the wrong time.
While discounts held steady in the month, NAVs are starting to roll over as credit spreads in both the investment-grade and high-yield market are starting to jump. The ICE BofAML US High Yield Master II OAS spread is now up to 4.59%, only ~70 bps from the levels reached in December.
Be careful about the potential for widening discounts as the NAVs continue to decline on the back of wider spreads. That could lead to compound selling by investors and cause fast-falling prices.
Our Core Income Portfolio was down slightly on a price basis during the month of May, far better than how the equity markets performed. The main driver was the fall in rates which boosted NAVs. In addition, fund flows are still decidedly positive in the bond world compared to continued outflows from the equity world.
Distribution Increase (>3%)
- John Hancock Investors Trust (NYSE:JHI): Distribution increased by 26.5% to $0.3111 from $0.2458
- Nuveen California Select Tax-Free Income (NYSE:NXC): Distribution increased by 6.6% to $0.0437 from $0.041
- Nuveen Arizona Quality Muni (NYSE:NAZ): Distribution increased by 5.5% to $0.0438 from $0.0415
- Pioneer Floating Rate (NYSE:PHD): Distribution increased by 4.2% to $0.0625 from $0.06
Distribution Decrease (>3%)
- Nuveen California Muni Value (NYSE:NCB): Distribution decreased by 13% to $0.047 from $0.054
- Pioneer Muni High Income Adv (NYSE:MAV): Distribution decreased by 11.8% to $0.0375 from $0.0425
- Nuveen Ohio Quality Muni (NYSE:NUO): Distribution decreased by 8.1% to $0.0418 from $0.0455
- Invesco Muni Income Opp (NYSE:OIA): Distribution decreased by 3.7% to $0.0316 from $0.0328
- MFS Muni Income (NYSE:MFM): Distribution decreased by 3.6% to $0.027 from $0.028
- Royce Value Trust (NYSE:RVT): Distribution decreased by 3.5% to $0.28 from $0.29
For a great summation of all the ongoing corporate actions in the CEF world, AST Fund Solutions' monthly CEF Insight letter is an excellent resource.
Alliance California Muni Income (NYSE:AKP): The fund announced that the shareholders approved the proposed liquidation of the fund. AKP will begin to transition its portfolio in anticipation of making its liquidating distributions. In connection with the liquidation, the fund will close its stock registry books and records at the close of business on Thursday, May 2, 2019. The proportionate interests of stockholders in the fund's assets will be fixed on the basis of their respective stockholdings at the close of business on May 2, 2019.
- The Fund expects to make one or more liquidating or other distributions to common stockholders. It is anticipated that liquidating and other distributions to common stockholders will be made on or about June 21, 2019. The Fund's preferred stock will be redeemed and preferred stockholders will receive the liquidation preference amount of each share plus accumulated but unpaid dividends and other distributions. It is anticipated that redemption of the Fund's preferred stock will take place on or about May 21, 2019.
Aberdeen Emerging Market Equity Income (AEF): The fund approved a cash tender off for up to 15% of the outstanding shares at 98% of NAV. The NAV is determined at the next business day following the expiration date of the tender. The tender will start on May 17th and expire one month later on June 17th.
- The policy requires the Fund to: (1) buy back shares in the open market when the Fund's shares trade at a discount of 10% or more to NAV, and (2) undertake a 15% tender offer if the average discount exceeds 11% of NAV over any rolling twelve-month period commencing on April 27, 2018, and ending on December 31, 2019, provided that the Fund is not required to conduct more than one tender offer during such period. For the period from April 30, 2018, through April 30, 2019, the Fund's average discount to NAV was 11.55%. As a result, the Fund is required to undertake a 15% tender offer pursuant to the Fund's targeted discount policy.
Delaware Enhanced Global Div and Income (DEX): The fund announced the board has authorized a tender offer to purchase for cash up to 632K shares, or 5% of the outstanding. The tender will commence on May 31st and end June 27th, unless extended.
- Purchases will be made at a price per share equal to 98% of the Fund's net asset value per share as of the close of trading on the first business day after the expiration of the offer; and
- if more shares are tendered than the amount the Board has authorized to purchase, the Fund will purchase a number of shares equal to the offer amount on a prorated basis.
EV Muni Bond (EIM): The fund announced the final results of its tender offer for up to 10% of the outstanding shares. The tender expired on May 17th, and since the number of tendered shares exceeded the 10% limit, the tendering will be done on a pro-rata basis.
- Following the purchase of the tendered shares, the Fund will have approximately 80,726,520 shares of common stock outstanding. The final results of the tender offer, based on a count by American Stock Transfer & Trust Company, LLC, the depositary for the tender offer, are provided in the table below: Number of Shares Tendered: 33,920,082 - Number of Tendered Shares to be Purchased: 8,969,613 - Pro-Ration Factor*: 26.4433706% - Purchase Price**: $13.374 - Number of Outstanding Shares after Giving Effect to Tender Offer: 80,726,520
BlackRock Science and Technology II (BSTZ): The fund filed a SEC form N-2 for an IPO on May 15th. The IPO price will be $20.00 per share. IPO date will be announced shortly. This fund will likely be similar to BST.
Angel Oak Financial Strategies Income Term Trust (FINS): Angel Oak Capital Advisors which runs the open-end fund ANGLX that is on the peripheral sheet has launched a closed-end fund that invests primarily in the debt of community banks. The fund will look and act similar to StoneCastle Financial Corp (NASDAQ:BANX) (Release).
RiverNorth Marketplace Lending Corporate (RSF): The fund will be listed on the NYSE as of June 12, 2019, and trade under the ticker RSF. It is an interval fund (release).
Vertical Capital Income Fund (VCIF): The shares were recently listed on the NYSE. The fund is run by Oakline Advisors LLC and is a closed-end fund that seeks income through the investment in residential whole mortgage loans. (N-CSR filing).
Monthly Statistics - Commentary
This is the sector data for the month of May. The best performer from a NAV perspective was the taxable munis (Build America Bonds, etc.) at +2.32%. That group was followed by the tax-free municipals, and then single state munis, up +1.22% and +1.19%, respectively.
The worst performers were various niche equity sectors like Asian equity (-6.63%), finance companies (-5.63%), and dividend equity (-4.81%).
Looking at sector z-scores, you can clearly see preferreds are in favor - no surprise given the drop in rates. The one-year z-score is up to +1.38 when just a year ago, no one wanted them due to markets being in a "rising rate environment." Preferred CEFs today look a bit expensive but could run as investors run towards duration.
Munis, both taxable and tax-free, have seen significant renewed interest compared to last year as interest rates have fallen and tax bills were paid in mid-April. We discussed this in early January that there was a significant opportunity here for both NAV gains and discount tightening. The z-scores reflect that as discounts have tightened to -5.87% from double digits. We continue to like munis; even high-yield munis are much more expensive today.
Looking at individual CEF positions, we saw a lot of volatility with many funds up big and just as many (if not more) down big. The largest price gainer during the month was XAI Octagon FR & Al Income (XFLT), which was recommended by another service on the site. The relatively illiquid fund saw a large increase in buying activity that sent the shares up 5.5% in a day and 7.2% over the last two weeks on over 10x the daily average volume. To us, the market is giving you a great opportunity to sell and de-risk a bit.
It has also been a marginal performer over the last year bested by many other funds in the space. Most of those funds are trading at large discounts to NAV rather than a premium.
Other big performers to the upside on price include several municipal CEFs like PIMCO New York Municipal Income (PNF), BlackRock Muni Income Inv Quality (BAF), and BlackRock MuniYield Quality (MFT) which all rose mid single digits. Flaherty&Crum Preferred Income (PFD) zoomed by 7.44% in the month and rose to a 5.01% premium compared to an average discount of -1.10%. It looks like this fund was also recommended by another service, causing the bounce, as the NAV was down during the period. This fund also looks like a solid sell candidate.
On the NAV side, the Build America Bond funds did the best including BlackRock Build America Bond (NYSE:BBN) and Nuveen Build America (NBB) which rose 3.10% and 2.45%, respectively. All of the largest gainers in NAV during the month were municipal-focused funds except for The India Fund (IFN) which jumped on the news of the Indian election results.
My favorite section on the below table is the top valuation changes (both increases and decreases). On the "valuation increase" (left side), there is PFD, which saw the valuation increase by 7.50%. XFLT is also there rising 7.19% in premium. This is often a good place to peruse to see which funds have increased in valuation the most and have possibly become good sell candidates.
Conversely, the right side shows the funds that have become more cheap with a fund like High Income Securities (PCF), a former Putnam fund that Bulldog recently successfully attacked, falling 4.67% in value. Given that the fund has a massive cash position, it will likely continue to fall. Be careful with this list as it typically houses the funds that have recently chopped their distribution or have stale NAVs.
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Disclosure: I am/we are long OIA, JHI, IVH. 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.