Closed-End Funds on the Cheap
By RANDALL W. FORSYTH
January 10, 2015
“When the year is done, there will be minus signs in front of returns for many asset classes. The good times are over,” declared Bill Gross last week in his monthly missive from his new digs at Janus Capital. As for more specific recommendations, he said he was saving them for the Barron’s Roundtable, which convenes this week. The product of its labors will be offered for your pleasure and enlightenment, beginning next week.
Of course, most strategists have penciled in returns on the order of 8% to 10% for 2015 from equities, as they seem to every year. Last week’s violent action, however, served to remind investors that a roller coaster winds up where it started, which provides excitement for some, nausea for others, but minimal progress overall.
Given the prospect of such a trip through 2015, it’s better to pocket income regularly, says Mark Grant, managing director for taxable fixed income at Southwest Securities and, in his ever-self-effacing estimation, “the guy who got it right” for insisting last year that bond yields would fall and not rise, as virtually every major Wall Street seer had predicted.
With Mark still seeing the odds tilting to lower, not higher, intermediate- and long-term interest rates, he says getting and cashing the monthly dividend checks from an array of high-yielding closed-end funds is the best bet for investors reading these scribblings.
To be sure, Mark opined in much the same vein in this space about three months ago (“Running Out of Bullets,” Oct. 6). Since then, however, the junk market got hit by the downdraft in oil, which hurt many leveraged energy credits. That only makes the funds he recommended better buys, he contends. Their streams of income have continued, and one of his picks, the Babson Capital Global Short Duration fund (ticker: BGH), paid a handsome extra distribution of 58.73 cents per share at the end of the year. That’s in addition to its regular payout of 16.77 cents per month, which provided an annual yield of 9.8%, based on Thursday’s close.
In that assessment, he is joined by the veteran market seer, Byron Wien, who put out his 30th annual list of “surprises” last week, from his perch at Blackstone Group. He writes in his widely read tally that “the year-end 2014 meltdown in the high-yield market, as a result of the collapse in the price of oil, creates a huge buying opportunity.” As junk-bond yields fall back and their prices rise, “high yield becomes the best performer of the various asset classes as the U.S. economy continues to grow with no recession in sight.”
Mark is rather less sanguine about the economy, especially because of prospects abroad, and again departs from the consensus that the Federal Reserve is certain to rachet up short-term interest rates. His bottom line is that in a world of continued low yields and high uncertainties, the bird-in-the-hand income from closed-end funds yielding upward of 9% is unbeatable.
It is obligatory to reiterate the quirks that make closed-end funds alluring to investors and simultaneously less interesting to the Wall Street marketing machine. While mutual funds or exchange-traded funds may continuously issue and redeem shares, CEFs issue shares in an initial public offering, at which point the cash is locked up. After that, investors can buy and sell shares on a stock exchange, where the price can be above or below the CEF’s net asset value (more likely the latter.) Many are small-cap stocks and trade that way; limit orders are highly recommended when buying or selling, denizens of this corner of the markets advise.
The ability to buy assets at a discount to their dollar value is one of the great attractions of the asset class. So, too, is the ability to use leverage; that is, to borrow to buy more, higher-yielding assets and thus boost returns. That, of course, is a double-edged sword when prices decline or borrowing costs rise, moves that tend to happen simultaneously.
Mark, whose day job is to service his big institutional clients, emphasizes that he is personally invested in these funds. Moreover, he says, he is indifferent about price appreciation, per se; their generous flow of income in a yield-parched market is what he’s after. But, he adds, after seeing 40 years of cycles, he expects high-yield spreads to tighten (that is, yields to fall and prices to rise) after concerns about shale plays dissipate.
Among the names he’s willing to share with Barron’s readers is Prudential Global Short Duration High Yield (GHY), a fund with a 7.28% discount from NAV and a yield of 9.42% as of Thursday’s close, reports cefconnect.com. Over 59% of its portfolio was U.S-based as of Nov. 30, according to the fund’s Website, with the bulk of the holdings in the middle of the junk range (double-B and single-B ratings).
Pimco Income Strategy II (PFN) yields 9.75% with a discount of 3.05%. Also, it’s managed by Mohit Mittal and Alfred T. Murata, the team that took over the fund from Gross when he departed for Janus last year. Unlike the flagship Pimco Total Return open-end fund, PFN has few constraints other than a limit of 20% on securities rated triple-C or lower, found at the nether regions of the junk market.
Mark also has made a point to diversify away from the high-yield sector, while maintaining income. That drew him to NexPoint Credit Strategies (NHF), which can hedge its holdings, which are in equities, bonds, and asset-backed securities. The fund’s shares yield 6.36% and trade at a steep 14.76% discount.
Another diversifier is Brookfield Global Listed Infrastructure Income (INF). With a 6.7% yield and a 6.04% discount, the shares have been under pressure, owing to the portfolio’s energy exposure via long-haul pipelines and master limited partnerships, its two largest sectors, as of third-quarter filings.
Finally, Mark also likes the BlackRock Municipal Target Term Trust (BTT), whose discount has widened to 13.13% for a positive reason—the share price has lagged behind the steady rise in the NAV. The federally tax-free yield of 4.67% translates to a taxable equivalent of 7% to an investor in the 33% tax bracket and 7.73% for one in the top 39.6% bracket. This CEF differs from most in that it has a termination date—Dec. 31, 2030—when it aims to return $25 a share to investors, analogous to a bond’s payment at maturity.
None of these funds provides the excitement of high-beta babies in the stock market. But after a week like the past one, that might be more than welcome