The mutual fund/individual stock hybrid that is the closed-end fund (CEF) can be a lucrative investment for those able to identify assets trading at deep discounts. With the major stock benchmarks trading near all-time highs, these funds offer some interesting opportunities given the largely overbought and overvalued nature of the market as a whole. For those with a long-term perspective, it makes sense to look at CEFs as a way of finding value in an already established bull market. But, which funds offer the best opportunities? Which CEFs are positioned with a solid portfolio foundation that will allow the stock to closed the discount to its net asset value (NAV)? Here we will look at some of the best CEF choices available for investors that are looking to gain exposure to this section of the market.
But, we will also look at one CEF that should be avoided, given its position in the current rate environment. This can help potential investors to see the differences (positive and negative) when gaining exposure to CEFs. One example of a CEF that should be avoided is the BlackRock Municipal Target Term Trust (BTT), which is showing gains of 10% year-to-date but is still trading below the midpoint of its 52-week range. BTT offers a 5.4% yield and currently shows a 7.4% discount to NAV. The stock sold-off heavily last year, as its exposure to long-term bonds make the fund vulnerable to rising interest rate environments (bond yields and prices have an inversely correlated relationship).
“The 22% decline seen in 2013,” said Sam Kikla, markets analyst at BestCredit, “brought the stock from its previous position trading at a small premium to a discount that is well below the 4.6% average that has been seen over the last three years.” The fund is made up of 44% leveraged assets which creates the potential for continued volatility -- not something to be viewed as desirable for conservative investors. An improving macro environment suggests that interest rates will begin rising and if this occurs, funds like BTT will likely meet continued selling pressure. A one-percent increase in interest rates could easily lead to double-digit losses in BTT stock, so it makes little sense to view its recent declines as a buying opportunity.
Stronger CEF Selections
But, there are still many attractive CEF selections that should be considered for long positions, given their steep and broader potential for gains. One excellent selection can be seen in the Center Coast MLP & Infrastructure Fund (CEN), which is one of the best ways of benefiting from rising energy demand at discount prices. CEN offers investors a well-positioned portfolio of energy infrastructure companies and Master Limited Partnerships (MLPs). Total leverage ratios come in near 26% and current valuations show an 8.3% discount to NAV. For those bullish on the sector, the Center Coast MLP & Infrastructure Fund offers one of the lowest risk options for gaining exposure along with a well-balanced selection of stocks that should see gains on positive changes seen in energy demand. With a yield of 7.2% and a market cap of 254 million, CEN continues to trade well off it its highs and should continue to strengthen throughout the year.
For those focused on dividend payouts, a solid choice can be found in the Nuveen Diversified Currency Opportunities Fund (JGT), which comes with a 9.4% 12-month yield. The fund looks to capitalize on opportunities in short-term debt (in emerging markets and in developed nations), and in high-yielding currencies. When dealing with high yield CEFs, it is important to know if distributions include a return of capital. In cases where investments fail to generate the expected yield, parts of the payout could include a return of principal. It should be noted that this is an issue JGT has dealt with in the past. but the overall strategy within the fund has held up in a wide variety of market environments. Along with this stability, JGT offers a massive discount to NAV of nearly 16%, so there are many positives here when considering an investment in the stock.