We are now past the halfway mark for 2015, and very little headway has been made for the vast majority of closed-end funds (CEFs). Examination of the two most popular CEF indexes shows mixed results year-to-date. The broadly diversified PowerShares Closed End Fund Composite ETF (NYSE:PCEF) is only marginally higher, while the more narrow-focused YieldShares High Income ETF (NYSE:YYY) has posted modest losses for 2015.
The key observation in examining charts of many taxable high yield and equity CEFs is they were well on their way into a strong tightening cycle as we traversed into 2015, following the volatility in credit securities last year. Yet nearly all of that headway has been given back as a result of macro issues abroad in addition to a sputtering domestic equity market. CEFs need risk assets to perform well to lure in a solid base of individual investors and then performance chasing will typically ensue. While the conditions haven’t been conducive to this type of story-book spread tightening scenario, CEF veterans should not be discouraged.
In fact many of the most popular funds that I track are at excellent relative values, and while it doesn’t happen often, our Dynamic CEF Income portfolio is fully invested with zero cash available to put to work in new funds. In my opinion, an underlying portfolio that is moderately leveraged and earning 8-10%+ in income is just too good to pass up, even if frightened individual investors disagree.
Instead, those types of investors would rather wait until interest rates stabilize, the Fed makes their first move, Greece’s problems dissolve, China gets back on track, and global growth lurches forward in the second half of the year. You may be resting on your laurels for quite a while.
The problem with waiting for uncertainty to dissipate is nearly every fund trading below its trailing twelve-month discount will begin to trend higher, and bargains will evaporate. As CEF investors finally feel confident enough to dip a toe back in the water, many discounts will have transitioned to premiums. By then the cyclical nature of investor psychology will have come full circle.
My objective is to have a counter-intuitive mindset and won’t hesitate to sell down concentrated positions to those investors eager to try their luck in financial assets they may not fully understand.
I point out these basic tenets to our readers because I know many of you have likely grown tired of the recent performance of the CEFs in your portfolio. Assuming additional risk in an investment without any marginal near-term reward isn’t the plot you had envisioned when you made your initial purchase. However, if you made solid intermediate-investments in funds that are managed appropriately given the opportunities in the market, I’m confident you will be handsomely rewarded.
Just be sure to remember that CEFs can develop and change trend quickly. In addition, those trends can last longer than most investors could have imagined. So my advice is to deploy your excess cash diligently, and hold your existing positions with a steady hand.
Disclosure : FMD Capital Management, its executives, and/or its clients may hold positions in the ETFs, mutual funds or any investment asset mentioned in this article. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.