Mid-Quarter Update: Good Start to 2014 for Many Categories of CEF Marketplace; Still Compelling Valu
Many categories of closed-end funds (CEFs) are off to a good start to the year. Investors took advantage of the big discounts to net asset value (NAV) and attractive yields available in the secondary market which helped push the average CEF up 2.57% the first 6 weeks of the year as measured by the First Trust Closed-End Fund Composite Total Return Price Index (UPCEFT) as of 2/14/14. In my quarterly CEF commentary piece from January, I discussed how there were as many compelling opportunities in the secondary market for CEF investors as there had been at any time since early 2009 from my standpoint based on, among other factors, very compelling valuations and attractive yields as leverage cost are still very low as the Fed continues to keep the Federal Funds rate at a rock bottom 0-0.25%.
As of 2/14/14, national municipal CEFs are up 6.83% as measured by the First Trust Municipal Closed-End Fund Total Return Price Index (MNCEFT), taxable fixed income CEFs are up 2.71% as measured by the First Trust Taxable Closed-End Fund Total Return Price Index (TXCEFT) and equity CEFs are up 1.59% as measured by the First Trust Equity Closed-End Fund Total Return Price Index (EPCEFT). Even with the solid start to the year for many categories of the CEF marketplace, I still find valuations and yields very compelling as underlying NAVs for many CEFs (particularly fixed income funds) have also performed well which has helped to keep discounts to NAV wide and attractive. Indeed, while average discounts to NAV for all CEFs have narrowed slightly since the end of 2013 from 7.33% to 6.59% as of 2/14/14 (according to Morningstar), they are still wider than where they were a year ago when discounts were 0.99%, three years ago at 2.51% and five years ago at 5.92% (according to Morningstar).
Furthermore, average yields remain very compelling at 6.72% (as of 2/14/14 according to Morningstar) compared to the average yield of 6.13% from one year ago as the theme of CEFs benefiting from low leverage cost remains very much intact. I see distributions for most CEFs likely remaining stable in 2014 as the majority of CEFs continue to earn a generous spread between leverage costs and the rates they can earn on borrowed proceeds. With the Fed unlikely to raise the Federal Funds rate until 2015 (based on what they have communicated to investors), this positive backdrop for the CEF structure remains in place.
In short, while many categories of the CEF marketplace are off to a good start to 2014, as the second half of the quarter commences there still remain many compelling opportunities available in the secondary market for CEF investors as average discounts to NAV remain wide, yields remain high and fundamentals for asset classes I favor including domestic equities, senior loans, high yield corporate bonds and municipal bonds remain sound.