Indiscriminate Selling Has Driven Closed-end Fund Discounts, Creating Compelling Value
Summary of Key Views
- The closed-end fund market, along with other financial markets in general, has experienced an enormous amount of stress over the past several weeks. Market volatility is extreme by any measure. Many funds have well underperformed relative to the assets in their respective underlying portfolios. This has caused much consternation about the vehicle.
- With all of the benefits attributable to the product, such as intraday trading, benefits of low financing costs of leverage, ability to be fully invested, consistent source of income, there are some idiosyncrasies in closed-end funds that can present challenges, especially during times of extreme market volatility.
- CEFs are often the first source for cash during times of market stress. Because there is significantly less interest in these products from institutional investors, these markets may at times trade at discounts, sometimes wide ones, due to a lack of value buyers to take advantage of large and frankly irrational price/NAV differences during periods of market stress. It is the rapid divergence of the CEF market price relative to its corresponding NAV that occurs when many retail investors sell en masse. That is exactly what we are seeing today: indiscriminate selling.
- Dislocations similar to today have happened previously, followed by strong recoveries. While CEFs should not be viewed as trading vehicles, today’s discounts on closed-end funds present compelling entry points.
Dislocations Have Occurred, Followed by Recoveries
Unlike publicly traded vehicles, such as stocks or many fixed income investments, as well as ETFs, financial buyers and sellers of CEFs tend to be overwhelmingly made up of retail investors. In addition, because of increasingly limited research available on the subject and lack of research coverage of most of the funds that are in the market, prices of CEFs are susceptible to wide swings and pressure during extremely volatile markets, like the ones that we are experiencing now.
We have been here before. It doesn’t necessarily take a “Black Swan” event, such as what we are witnessing, to cause these dislocations in the CEF market. They may have similar, if not as dramatic, reactions during lesser and more common periods of volatility.
We saw that very dynamic 18 months ago in the quarter of 2018, a volatile period going into the year’s end. Although the CEF NAVs generally held up respective of their respective benchmarks, the prices did not.