When managing a portfolio of closed-end funds (CEFs), sometimes the valuation of funds you own are less important to consistently evaluate than the funds you don’t own. This is a key reason why every CEF investor should maintain a watch list of familiar funds.
But unlike watching a list of equity ETFs, where nearly every move is relatively correlated with the daily fluctuations of S&P 500 index, and small divergences happen over time. In CEFs you can actually view dislocations happen in real time, since there is no guarantee of any meaningful correlation with fixed income or equity prices.
In the ETF universe, I have found that investors will consistently be drawn to buying the newest fund launches or smart beta strategies, while shunning old or boring strategies. With CEFs, you have to consistently look back, and often times, the best opportunities can arise from funds you once thought were no longer of value at a given point in time.
This exact scenario happened last week at our firm, when I was evaluating and updating our watch list, I uncovered a small dislocation in fund that we actually sold in late May of 2013. The DoubleLine Opportunistic Credit Fund (NYSE:DBL) was a holding within our Dynamic CEF Income Portfolio that we originally jettisoned because the premium had stretched egregiously past its trailing-12-month average.
Yet, likely as a result of recent equity market volatility, the market price of DBL slouched from its most recent high. Still, in light of recent shifts in the fixed income markets, the underlying net asset value (NAV) performance of DBL has risen significantly and even outpaced its peers. This offered what I believe to be an excellent opportunity to re-initiate exposure in DBL for our CEF portfolio.
For those that might not be aware, DBL is one of the few funds in the CEF universe that trades at a consistent premium to its NAV as a result of management star power; Jeffrey Gundlach, and its ability to create meaningful alpha above its benchmark. In fact, it’s not uncommon for DBL’s premium to reach levels as high as over 10% from its NAV.
At the time we made our purchase, these two convergences compressed the premium of DBL to roughly 2%, a level that the fund has not revisited since November 2014. Currently DBL yields over 8% on a market price basis and has consistently generated enough income to cover its distribution policy. In addition, DBL uses only 20% leverage to achieve that feat.
From a fundamental perspective, I also favor the portfolio style of DBL in the current volatile environment because it adds an element of quality fixed income assets to counterbalance the heavy credit weighting we already carry.
Unlike Gundlach’s flagship DoubleLine Total Return Bond Fund (MUTF:DBLTX), DBL has a much larger credit sensitive securitized asset sleeve made up largely of non-agency commercial and residential mortgage backed securities. In addition, the fund also utilizes agency derivatives to a much larger degree due to their illiquid nature and the associated advantages of a closed-end fund wrapper.
These types of securities enable a portfolio to strip out certain characteristics among traditional pass-through securities such as principle only (PO), interest only (IO) and inverse floaters (IFRN) to make strategic bets on the prepayments, interest rates and duration.
As a result, Gundlach has done a masterful job of controlling duration and credit exposure following the volatility in high yield bonds in the latter stages of 2014. As a result of DBL’s more aggressive strategy in comparison to DBLTX, the fund’s underlying NAV performance is up over 4% year-to-date.
We view this holding to be a perfect intermediate- to long-term complement to our other DoubleLine CEF — the DoubleLine Income Solutions Fund (NYSE:DSL) — since DBL has a concentrated portfolio dedicated almost exclusively to the mortgage sector.
So, while it wasn’t our immediate intention to favor DoubleLine over other funds on our watch list, it turns out that doubling down on Jeffrey Gundlach is almost always a smart bet!
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