Year-End Opportunity in Closed-End Funds
Having invested in Closed-End Funds (CEF) many times in the past, I’m on the lookout when opportunities present themselves because yields can be enticing if the discounts to Net Asset Value (NAV) are wider than usual.
An article by Brendan Conway, author of the “Focus on Funds” column of the Wall Street Journal caught my eye this weekend. Discounts have widened for CEFs lately; likely due to year-end tax loss selling according to Conway. Discounts are twice as large as normal with the discounts being most pronounced in bond and precious metals CEFs.
Here’s a look at why. (1) Investors have experienced a sharp enough rise in the stock market that they’re searching for losses to offset large tax bills. (2) For many mutual funds and ETFs, financial-crisis losses are off the books, so capital-gains distributions are on the rise. (3) Many investors suffered their first down year in bond and precious-metals funds in some time. Opinion is glum on the latter two assets.
Three charts put the current situation in perspective. First, a look at the seasonality of CEF discounts which shows that the largest discounts to NAV typically occur in December.
Next, current discounts on CEFs in relation to their recent history:
Finally, the perspective of the financial crisis of 2007-2009 indicates how truly wide discounts in CEFs can get when the markets unravel; leading to horrific losses for investors. Some leveraged CEFs lost 90% of their value while their discounts exceeded 20%.
The SMA Portfolio has a significant cash balance (over 20%). I will be placing bids on a couple of closed-end funds, one of which is Western Asset Emerging Markets Income Fund (EMD). EMD has suffered a serious decline this year on fears of Fed tapering and currently trades at a 15% discount to NAV, with an annual distribution yield over 8%. EMD has an annual expense ratio of around 1.25%. EMD has a small amount of leverage currently (less than 5% according to information sources). It should be noted that EMD’s management attempts to maintain consistent dividend distributions and could resort to distributions from capital if net investment income and net capital gains are insufficient to achieve the stated distribution amount. Also note that EMD is a bond fund and is more suitable for inclusion in a tax-free rather than a taxable account.
There will be an additional post when and if the investment in CEFs is accomplished.