CEF Report July 2023 | Valuations Are Up But Value Remains. Caution Still Warranted

Summary

• CEFs remain cheap but are showing signs of life in both NAV returns and discount returns.

• The CEF market is one where you really want certain economic conditions to exist.  Wide credit spreads, large discounts to NAV, and an upward sloping yield curve.

• Only one of those conditions exists today- the large discounts- likely as a result of the other two conditions not.

• There are some decent buys but overall we have kept our allocations low in favor of individual bonds.

Closed-end funds ("CEFs") remain a popular way to access steady income, especially in retirement.  I also feel like they fulfill the "do something itch" - where investors feel like they need to do something and be active.  That is, buying at a large discount and selling with the discount closes, swapping to a different fund at a large discount.  And repeat.

Today discounts remain extremely wide, especially in municipal bond CEFs.  There is a reason for this: CEFs are largely owned by retail investors who tend to be spooked by higher rates.  In this case, that fear is justified as higher short-term rates and a yield curve inversion makes the typical muni CEF uneconomical.

The reason being is that they are paying more for their leverage (interest expense) plus the other fees than they are earning on the muni bonds being purchased with the borrowed funds.

This is why, according to RiverNorth Funds, municipal bond CEFs are trading in the 98th-99th percentile for discounts.  That means, going back to 1996, discounts have only been wider 1-2% of the time.  This is as cheap as they get for those that are discount hunting.

Buy The NAV, Not The Discount or Yield