CEF Discounts Narrow and Attractiveness Wanes

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Closed-end funds (CEFs) always have a way of being late to the party, both on the upside and downside.  During the most recent correction, many popular CEFs barely flinched until volatility picked up heavily on the downside and we were already 5-7% off the highs in the major averages.

Conversely, with the market having rallied substantially during the last 6 weeks, many CEFs have lost their relative attractiveness as new money pours into aggressive high income strategies.

Looking at our in-house watch list, we follow our favorite CEF’s premium and discount history in relation to their trailing twelve month averages.  While those averages have been in decay for virtually the last 12 months, most CEFs have snapped back above them as a result of new-found optimism in risk assets.

No surprisingly the majority of the attention has gone to badly beaten down high yield corporate bond and bank loan sectors of the CEF market.  As a result of leverage and an extremely unfavorable underlying asset class, many of these funds lost 20-30% of their value during the 1st quarter alone.  Yet, while many of these funds have recovered sharply, most are still 10-20% from their pre-correction trading levels.

At first glance this may seem very attractive still, however, we believe that many funds have come too far, too fast in respect to discount contraction and NAV performance.  From a strategic perspective, for clients in our Dynamic CEF Income Portfolio, we are waiting out some better opportunities with the small amount of cash we have available to deploy.

In our opinion, 2016 will prove to be a very difficult investing environment, and with a third of the year almost gone, we want to insure that any new investments will endure the intermediate term. Most importantly, don’t get caught up the stampede mentality that is so prevalent in CEF investing.

Wait until funds on your watch list present the maximum amount of valve given their inherent risks.  Lastly, short term trading of CEFs can be a dangerous game of cat and mouse, instead, look for funds that you can capitalize on the income while you wait for the discount to narrow or premium to expand.

The post CEF Discounts Narrow and Attractiveness Wanes appeared first on FMD Capital Management.

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