The holiday shopping season is in full swing. For investors, it’s the time of year to go foraging among items that are being dumped to realize losses for tax purposes. Denizens of that rather obscure corner of the financial markets, closed-end funds, look forward to snatching bargains among the discards tossed out by those looking to use losses there to offset gains elsewhere.
With the market averages at records, however, there are relatively few markdowns to be had either in equity and credit markets, which is a high-class problem. And after strong rebounds from the steep losses of late 2018, savvy buyers of CEFs who swooped in to take advantage of those bargains, as recommended in this column at the time, now are sitting on hefty gains in almost all cases.
If anything, owners of closed-end funds are more likely to be cashing in profits than cutting losses, says Sangeeta Marfatia, senior CEF strategist at UBS Global Wealth Management. So they may prefer to wait in order to gain favorable capital-gains tax treatment, which requires a 12-month holding period. They also may not want to sell until the new year, so that the capital gains go on their 2020 tax bill, due April 15, 2021.
Investors who followed Marfatia’s recommendations last December would be sitting on total returns (capital appreciation plus income) of as much as 34.16%, in the case of the Calamos Strategic Total Return fund (CSQ), from the beginning of the year through Tuesday’s close, according to Morningstar.
Those gains came off the depressed levels of last December and are unlikely to be repeated. Marfatia does see a few CEFs selling at discounts that can provide income, however.
With the reversal of short-term interest rates to the downside this year after 2018’s increases, there’s less worry about distribution cuts. Most closed-ends use leverage to boost income, but when borrowing costs rise, fundholders typically see payout reductions. That risk is lower, with the Federal Reserve likely to hold rates unchanged at least through the first half of the coming year.
The bad news is that there now are few cheap CEFs, either on a relative or absolute basis, adds Maury Fertig, chief investment officer at Relative Value Partners. “There are slimmer pickings this year,” agrees Steve O’Neill, portfolio manager at RiverNorth Capital Management, which specializes in managing portfolios of closed-end funds.
With that caveat, these pros do find some worthwhile buys.
O’Neill suggests pairing funds that invest in corporate loans with those that specialize in long-term municipal bonds. While he can’t name specific picks because RiverNorth is constantly trading its funds, he says this “barbell” minimizes interest-rate risk. Such a combination would include loan funds with interest rates that float with short-term benchmarks such as Libor (the London interbank offered rate), and thus are insensitive to rate changes, along with muni funds with long durations (a measure of bond prices’ sensitivity to yield change). Loans are sensitive to the economy’s ups and downs, as they are issued by leveraged companies, while high-grade muni bonds are defensive and would tend to rally if the economy weakens and yields decline.
One loan fund that Fertig likes is BlackRock Floating Rate Income Strategies (FRA), which closed at a steep 10.74% discount from its net asset value Tuesday, while yielding 7.34%. The loan market has been hit with outflows from open-end and exchange-traded funds amid burgeoning default worries. But Fertig calls those concerns “a little overblown,” with investors pricing in a recession.
Among muni funds, Marfatia likes Nuveen Municipal Value (NUV), the original muni CEF, which is unleveraged, yields 3.45%, and trades at a slim discount under 1%. For another unleveraged fund, she picks Nuveen Select Tax Free Income Portfolio 3 (NXR), which was yielding 3.32% and trading at a 4.32% discount, as of Tuesday’s close.
Among closed-ends that emphasize both income and capital appreciation, Marfatia suggests Eaton Vance Tax-Advantaged Global Dividend Income (ETG). It recently was yielding 7.09% while trading at a 3.88% discount to net asset value, close to its lowest level of the past year. She also highlights CBRE Global Real Estate Income (IGR), which had 36% of its assets in non-U.S. investments as of Oct. 31, according to its website. Its distribution yield is 7.54%, while its discount of 10.06% is slightly higher than its 52-week low of 9.14%, according to CEF Connect.
Fertig likes AllianzGI NFJ Dividend Interest & Premium Strategy (NFJ), which he says is relatively cheap, with a 11.10% discount, owing to its value-investing style, which may be coming back into favor. Its portfolio includes 68% common stocks and 29% convertible securities. Its yield of 7.07% isn’t enhanced by leverage but instead by the sale of call options, which generates income but limits potential appreciation.
Finally, for something completely different, Fertig favors Special Opportunities (SPE), a fund run by activist investor Phillip Goldstein. It has stakes in other CEFs, trades at a 9.35% discount, and has a distribution yield of 6.36%. Its 2019 NAV return of 19.47% (26.66% based on its share price) has been achieved with about half the volatility of the S&P 500 index (.SPX), he adds.
As for the biggest losers—master limited partnerships (MLPs) and closed-ends that invest in them—there still are few fans, despite their continued battering. In addition to the sector’s ongoing bear market, RiverNorth’s O’Neill points to an additional risk in leveraged MLP CEFs. The slide in their MLP holdings could require them to reduce their borrowing to remain within their leverage limits. That, in turn, could force them to dump MLPs at the worst time and lock in losses.
Harley Bassman, the former head of mortgage securities at Merrill Lynch and author of the Convexity Maven blog, admits that he’s been “long and wrong” in MLP CEFs. But he also insists that the “bloodbath beyond comprehension” in the sector makes MLPs the best opportunity available, given today’s low interest rates.
The unleveraged Alerian MLP exchange-traded fund (AMLP) yields nearly 10%, about four percentage points more than high-yield corporate bonds, Bassman points out. But, he adds, don’t expect a quick rebound, given MLPs’ structure, which limits institutional investors’ interest in the group, and the lack of fondness for fossil-fuel-related investments among those with ESG (environmental, social, and governance) investing guidelines. Funds that buy MLPs eliminate onerous K-1 forms for tax payments but lose other tax benefits, he notes. Nothing is easy in this bruised and battered sector.
|For more news you can use to help guide your financial life, visit our Insights page.|