When Premiums Become Too Good to Pass Up

It’s been an unsettling few years for closed-end fund (CEF) investors, as volatility has hindered returns in what would otherwise be a fruitful investing environment.  It all began with the “taper tantrum” and the knock on effects that followed.

More recently, the lingering adversity in this space has been caused by the long impending interest rate hike. In fact, it’s been roughly two years since CEFs as a whole have moved from deep discount territory to narrower sale prices and more abundant premiums.

Strategies that utilize CEFs such as our Dynamic CEF Income Portfolio and our Flexible Growth and Income Report utilize discount expansion and contraction to achieve above average returns.  Yet, with very little to get excited about over the last several years, we have been forced to trade even the smallest price and NAV fluctuations.

From a historical context, it wasn’t uncommon for a fund to swing from a 4% discount to a 10% discount and back again.  This type of volatility offers a source of alpha that isn’t dependent on the underlying asset class’ performance.   Lately, discounts have largely languished, as individual investor appetite for even relatively attractive discounts has been impeded by the aforementioned interest rate factors.

In addition, the IPO wave leading up to mid-2013 was record setting, with a few of the largest CEFs in history sold to individual investors at hefty prices.  In hindsight, this was likely a significant leading indicator of bleak intermediate-term performance.

Although, it hasn’t been all bad, we’ve been fortunate to find ways to outperform our benchmark in recent years by largely capitalizing on some of the misfortune in the market place.

One such investment that comes to mind is our holding in the DoubleLine Opportunistic Credit Fund (DBL).


As followers of our blog know, we’ve been big fans of DBL ever since it entered rarely seen discount territory in mid-2015.  We actually made two separate purchases that totaled roughly 10% in our Dynamic CEF Income portfolio.

For those that don’t know, DBL is somewhat unique because the portfolio composition is 50% long duration high quality mortgage backed securities.  This component was key during the last several months because they were able to shore up the declines in the below investment grade non-agency mortgage backed security side of the portfolio.

As a result, DBL’s net asset value (NAV) was very stable during the most recent wave of credit volatility.  That fact alone, in addition to the fund being managed by Jeffrey Gundlach, attracted investors in droves.  Other fundamental factors that contributed to the rise in market price are the moderate asset size of roughly $335 million and it very loyal base of shareholders.

Last week, we made a tactical decision to cut our position in DBL in half, following the fund reaching a 13% premium to its NAV on an intra-day basis.  In our opinion, when a fund trades at a 10% premium above its 12-month trailing NAV, which also happens to outstrip its annual income by 110%, the premium is simply too good to pass up.  In fact, we can sit in cash for over a year and wait for another advantageous entry point for DBL, without necessarily sacrificing any lost income that we realized through capital appreciation.

While situations like DBL have been sparse, we look forward to the time when CEFs can return to an environment that favors alpha-seeking income investments.

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