Prices Are Getting A Bit Frothy In Some Areas Of The CEF Market

We sent a morning note to our members of Yield Hunting as well as members of our new multi-tier service, Diversified Income Streams.  

Yesterday, the biggest news came post-mkt with AMZN beating earnings then Jeff Bezos announcing he is stepping down as CEO in Q3, letting the CEO of AWS, Andy Jassy, take over in Q3. During the session, the risk-on rally continued. Banks (10Y back to 1.1%) and Industrials led. Despite WTI breaching $55, Energy underperformed. Defensives came for sale.

In CEFs, we had another good day yesterday with most sectors up on NAV and discounts tightening. Obviously equity focused funds did well thanks to the zooming markets. But we also saw defensive bond areas do well like munis rising 0.05% on NAV and 0.25% on discounts. High yield did well also rising 0.2% on NAV and 0.3% on discount (meaning that price moved 0.5%).

Global income, preferred, and real estate were the only “bond” sectors that saw wider discounts and it was only marginally.

We are getting to the point- especially in the last few days- where there are far more things that I find expensive and “sell worthy” than anything to buy. Finding something sensible to commit my money to has become extremely hard work. For most of 2020, it was the opposite: you could throw a dart and hit something cheap and potentially a good buy. So let’s spend some time on some sells. Not everyone is tactical and wants to sell. Some care primarily about the distribution and do not concern themselves with the underlying fund valuation. That is fine.

For example, BTZ is a long-held staple of the Yield Hunting Core Portfolio. The discount has narrowed to -4.7%, about 3 points tighter than average. The 5 year high discount is -2.8% so we have less than 2 points to go to reach that new high. The fund is a great fund but there is a lot of discount risk at -4%. I’m still holding for now but will continue to watch.

Sister fund BIT is much the same. Now at a -4.5% discount and only 0.9% from the five-year high.

ECF is now at a 5%+ premium and very much a sell in my book. I would rotate to CCD or CHI.

NSL, JRO, EFT and EFR, all in the floating rate space, have risen dramatically in price and tightened up their discounts. While these funds are at or very close to one-year highs, they have a lot of room to reach 5-year highs as many hit NAV back in late 2016/early 2017 when rates jumped following the Presidential election and money poured into loan funds- much like what is happening today. Still, the yields are lower today after large cuts so I don’t expect them to reach par. They may have a couple of more points to go but I don’t think the risk is worth it.

The chart below shows the distribution yields of the funds over the last five years. You can see they were materially higher 5 years ago over 7.5%-8.0% when today they are in the 6% and even 5% range. So I think they will struggle to see their discounts tighten more as investors won’t want a leveraged non-investment grade fund yielding less than 5.5% or 5.0%.

In loans, stick with PHD or the Blackstone/GSO funds- BSL, BGB or BGX.

In high yield, MCR, GGM, HNW, and PHT are all expensive and are good swap candidates. HIO is a good place to rotate in to along with KIO, PHK, and DHY.

In PIMCO, PCM looks a little frothy as the premium continues to rise and is now at +18%. Typically this fund trades around 10%-11% premium.

Have a great day!

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