Weekly CEF Market Report - January 24, 2021
Deep Value, Contrarian
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2) George Spritzer - Another career financial guru who runs a registered investment advisor with a specialization in closed-end funds for individuals. George uses the following investment strategies:1) Opportunistic Closed-end fund investing: Buy CEFs at larger than normal discounts to NAV and sell them when the discounts narrow. 2) Exploit special situations: tender offers, fund terminations, fund activism, rights offerings etc.3) Landlord Investor- spent his career as a management consultant for public sector clients at a multinational consulting firm in the DC area. He has transitioned to a new career as a full time landlord. His investment portfolio is comprised of two parts -- broad-based index funds and income plays such as preferred stock, CEFs, and REITs. He also owns individual/baby bonds which he buys on margin to boost total return. Landlord is our 'individual preferred stock' expert analyst.
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Macro Picture
Like a broken record, stocks edged higher to new record highs on the week boosted by strong gains in technology. Netflix announced very strong earnings along with Google and Facebook's stock rising nicely. Energy shares lagged on a large rise in US inventories. The recent rotation into small caps and value stocks reversed a bit.
The hopes for a large stimulus bill drove some of the gains with Treasury Secretary nominee Janet Yellen wanting to "go big" in order to help the economy and unemployment.
Coronavirus also helped sentiment with new cases appearing to top out and President Biden's stated goal of 1 million vaccinations per day for the first 100 days. Not sure if that means 50M people getting both doses or 100M people getting one dose.
Housing remains extremely strong with inventories at the lowest levels on record. Existing home sales and housing starts are back to levels we saw during the housing boom years of 2005-2007. The supply of unsold homes would be exhausted in just 1.9 months, the lowest supply going back to 1982. We also had strong Markit gauges for both manufacturing and services in January.
Commentary
Fixed income discounts did tighten about 20 bps in the last week with broad strength on Wednesday and Thursday. Overall, however, discounts are struggling to get tighter despite a typically strong month in January ("January effect"). This is likely due to the geopolitical issues that have plagued us in the last few weeks which has prevented the VIX from falling back below 20. Additionally, we had a mini-scare of higher rates earlier in the month which could be creating a bit of hesitancy in some CEF investors.
In my experience CEF investors fear rising rates above nearly everything else. The move in the 10-yr from 0.91% to 1.18% in about 8 trading days earlier in the month. Higher interest rates can hit the CEF investors in two ways. It reduces the value of the underlying bonds (interest rates and bond prices move inversely to each other) and it can increase the cost of leverage reducing the earnings power of the fund.
Remember, as CEF discounts tighten, most of us will want to rotate out of them and into open-end funds to protect the downside. That is to avoid the massive drawdowns that can occur in CEFs from discount widening. That is the opportunity to rotate back in at cheap valuations. The problem is, of course, we don't know when they will happen. Despite me pounding the table back in February 2020 that valuations were extremely tight, it was impossible to know a pandemic would be around the corner and slaughter CEF prices.
Just as easily we could have seen those tighter valuations last for months, even years. So we typically advise the rotation from tight CEFs to mutual funds to be a slow process. But investors need to realize that at any point, we could see another deleveraging event. In reality, those events are rare occurring once every 5-6 years.
Rotating to the best sectors and funds within those sectors can cushion the blow but not eliminate it. That means looking at convertibles, loans, and perhaps global income.
One option is to stick to term and target term funds. Given that these funds liquidate at some point in the future they tend to stick closer to their NAV. That is because the shareholder gets back NAV at liquidation so the discount closes.
Using the term funds tab on the Google Sheets, investors could pick up shares while minimizing downside risk. Of course, you have to believe that the fund sponsor will actually liquidate the fund and not, at the last moment, shift it to a perpetual fund.
On the Term fund sheet, what I look for is 2.0%+ tailwind yields. That is the amount of annual discount tightening one could expect as the fund approaches the liquidation date. I focused heavily on the sectors mentioned above (convertibles, loans, global income).
- Allianz ("Virtus") Convert & Income 2024 Target (CBH): I like this fund and loaded up a bunch of it on Friday when it hit my limit order of $9.90. The fund liquidates Sept 1, 2024 at NAV with a target liquidation of $9.83. It is a mix of convertibles, high yield, and loans.
- First Trust HY Opportunities 2027 (FTHY): We discussed this fund a lot in the last week as the fund saw a massive alligator mouth. Another service wrote it up and the price popped a bit. Given the termination is so far out it is trading like a perpetual. That will change in a year or two. Typically, when a fund is within four years of liquidation it starts tightening up, often for good. It's an "ok" buy here but I like other stuff better unless you really want that term feature.
- First Trust Sr Floating Rate (FIV) cut their distribution again as they approach the wind down period for the fund. I saw another contributor post that the sponsor isn't great about actually terminating their terms. In this case, I would say it is almost certain to liquidate in one year (Feb 1, 2022) given it's a target term and they are chopping the distribution. The payout is about 22 cents above the current NAV. Highly likely to get there now that they cut again. Just in the last month they've gained 18 cents of NAV. Total return looks to be about 8% in the next year. Not a bad buy for some "safer" capital.
Outside of the terms, I would look hard at the Calamos Convertible funds that just rose. I mentioned CHI on Thursday and then they raised that day- which was not anything smart as the distribution is a percentage of NAV and the NAV is up nicely! The discount tightened up by 70 bps on Friday on the news but I still like the fund here.
I continue to like Pioneer Floating Rate (PHD) and KKR Income Opps (KIO) for floating and floating/high yield mixes.
Stay tuned to the morning notes where I will be focusing on one or two compelling funds as well as swaps this week.
Sectors Results:
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1) Alpha Gen Capital - I am a career financial advisor (non-practicing) and investor. Not someone from another career doing this on the side. The AGC team and I use detailed analysis to provide safe and actionable insight without the fluff or risky ideas of most other letters. Our goal is to provide a relatively safer income stream with CEFs and mutual funds. Maybe more importantly, we also help investors learn about investing and how to properly construct a portfolio.
2) George Spritzer - Another career financial guru who runs a registered investment advisor with a specialization in closed-end funds for individuals. George uses the following investment strategies: 1) Opportunistic Closed-end fund investing: Buy CEFs at larger than normal discounts to NAV and sell them when the discounts narrow. 2) Exploit special situations: tender offers, fund terminations, fund activism, rights offerings etc.
3) Left Banker - Is a retired individual investor. Left Banker is well known on Seeking Alpha for his analysis on closed-end funds. He is adept at analyzing rights offerings in a straight-forward manner so that investors can understand it. He has written over 320 articles- mostly on closed-end funds- and has over 11,200 followers.
4) Landlord Investor- Spent his career as a management consultant for public sector clients at a multinational consulting firm in the DC area. He has transitioned to a new career as a full time landlord. His investment portfolio is comprised of two parts -- broad-based index funds and income plays such as preferred stock, CEFs, and REITs. He also owns individual/baby bonds which he buys on margin to boost total return. Landlord is our 'individual preferred stock' expert analyst.
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