Weekly Commentary | February 10, 2019

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Stocks managed to eek out another weekly gain last week, the seventh consecutive as the bear market of the fourth quarter seems like a distant memory.  Energy lagged while utilities and industrials outperformed.  

For us, the important points to highlight first and foremost is the VIX which hit a 5-month low on Wednesday before inching higher the rest of the week.  At 15.7, the index is less than half what it was during the week of Christmas.  

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Global growth concerns remain the most pressing risk the market is facing.  Last week, Eurozone policymakers cut their economic growth forecasts to a 1.3% annual rate in 2019, down from 1.9%.  The bulk of the slowdown is being blamed on slowing Chinese demand for their products.  

We have also been fading the trade deal optimism in the last couple of weeks as news came a few days ago that President Trump and President Xi will not meet when Trump visits Asia later this month.  Nonetheless, top trade officials including Lighthizer and Treasury Secretary Mnuchin are flying to Beijing this week to continue talks.  

Lastly, the Fed Chief Powell said this week that the economy is "in a good place".  We received ISM services data last week that while still at a high level, did slow for the second consecutive month.  Powell had dinner with Trump at the White House where they discussed recent economic developments and forecasts.

Some other key news during the week was a federal judge approving the restructuring of $17B of bonds backed by Puerto Rico Urgent Interest Fund Corporation, known as COFINA.  Bondholders agreed to a deal that would split revenues from the sales-tax backed debt and the government.  It was one of the largest deals done so far in the Puerto Rican bankruptcy process.  PR muni bonds rallied on the news.

Concluding Thoughts

Nothing has changed from the narrative of the last few weeks.  We still have the trade overhang, the government shutdown looming, and global growth slowing as the major risk impediments.  The market doesn't seem to be too phased by them.  The major trends in the market are in place and incremental news on any of those three subjects can move it but not de-rail the trend.  

High yield bond spreads are still elevated above the post-recession lows.  The index sits at 429 bps as of last Thursday (Friday's data isn't posted yet).  This is still ~90 bps above the 3.35% registered in September.  As the VIX cools and the risk-on sentiment in corporate bonds continues, the spread should continue to inch lower.  That should be supportive of bond CEF NAVs across or portfolios.  

The same could be said of the investment grade option adjusted spread which sits at 134 bps, well above the levels set in early 2018 when it reached just 90 bps.  

From JP Morgan: 

US equity outlook – the SPX is consolidating and digesting but the rally isn’t over just yet (although the upside potential isn’t dramatic). ~$172-173 (EPS) and 16x (PE) are still reasonable numbers and they support the SPX at ~2750 (investors should be wary of chasing beyond 16x/~2750 but given how emotional this market can get, an overshoot could easily occur and ~16.5x would put the index at ~2800). Investors have plenty to be nervous about (including the ongoing growth softness in Europe and the risk this drags the other major geographies down with it) but US trade policies shouldn’t be high on the list (trade rhetoric will stay a problem though). • Some of the next major macro events to watch in the weeks ahead: China’s Jan trade data (Thurs morning 2/14), US gov’t funding expiration (Fri 2/15), FOMC minutes (Wed 2/20), flash PMIs for Feb (Thurs 2/21), Powell’s Senate testimony (Tues 2/26), Powell’s House testimony (Wed 2/27), TrumpKim summit (2/27-28), US Q4 GDP (Thurs 2/28), US-China ceasefire deadline (3/1), US jobs report for Feb (Fri 3/8).

Closed-End Fund Analysis

Distribution Increase

Pioneer High Income (PHT):  Monthly distribution increased by 3.9% to $0.0675 from $0.065.

Distribution Decrease

Pioneer Muni High Income (MAV):  Monthly distribution decreased by 19% to $0.0425 from $0.0525.

Delaware Div & Income (DDF):  Monthly distribution decreased by 2.9% to $0.0887 from $0.0913

Delaware Enhanced Global Div & Income (DEX):  Monthly distribution decreased by 2.2% to $0.0887 from $0.0907

IPO/N-2 Filing

Cushing Real Income & Preferred Fund - the fund filed an N-2 on Feb 1 to list their shares.  The ticker and the IPO date will be announced shortly.  

Activist Trading

First Trust Portfolios 

  Buying:  AWP, ASG, CET, KSM, EVF, GGT, FMO, JRO, PHT, IRR  Selling:  AIF, RFI, EFF, KIO, EMO, HNW, SMM

SIT Investment Associates

  Buying:  SPE, CLM, EVG, FTF, VLT, LOR, GFY, TLI, JMM, HNW, PPT, WIA

  Selling:  AGD, BKT, BTA, SRV, CRF, INSI, DEX, DUC, FAM, VBF, JHS, PIM, 

Tender Offer

China Fund (CHN):  The fund announced the expiration of their tender offer to purchase up to 30% of the fund's issued and outstanding shares.  

  • Based upon current information, approximately 11,800,248 Shares, or approximately 75.05% of the Fund's Shares, were tendered and not withdrawn through the Termination Date, including shares tendered pursuant to notices of guaranteed delivery. Because the number of shares tendered exceeded 30% of the Fund's outstanding Shares, the Fund will repurchase the maximum number of Shares covered by the Offer (4,716,803 Shares) using the pro-ration procedures described in the Offer to Repurchase included in the Fund's tender offer materials provided to stockholders.

Liquidation

Alliance CA Muni Income (AKP):  The fund announced that the board of directors has approved the liquidation of he fund, subject to shareholder approval. 

  • It is anticipated that the Plan of Liquidation and Dissolution will be submitted to ACMIF's stockholders at a special meeting to be called for that purpose on April 26, 2019. The close of business on February 19, 2019 has been fixed as the record date for the special meeting of stockholders.

 Investment Policy Change

Blackrock Credit Allocation Income (BTZ):  The board changed the non-fundamental investment policy.  The change is meant to increase the flexibility of the fund to continue to invest in what Blackrock thinks are the most attractive credit opportunities.  The change is expected to take place as of Feb 8th.  

The main shift in policy changes the amount that the fund can invest in non-US securities from 35% to 50%.  This may include dollar-denominated and non-dollar denominated securities.  

  • New Policy: Under normal market conditions, up to 50% of the Fund’s Managed Assets may be invested in non-U.S. securities, which may include securities denominated in U.S. dollars or in non-U.S. currencies or multinational currency units. Average Credit Quality. The Fund’s existing investment policies permit it to invest, under normal market conditions, without limitation in securities rated below investment grade at the time of purchase.

  • Notwithstanding this policy, the Fund has previously disclosed that it was anticipated, under then-current market conditions, that the Fund would have an anticipated average credit quality of at least investment grade. BlackRock currently intends to manage the Fund’s credit quality in accordance with its stated investment policy, which means that at times the Fund’s average credit quality may be at or below investment grade. There are no changes to the Fund’s investment objective or to other investment policies of the Fund.

Weekly CEF Statistics

First, the stats on the Core funds showing the top and bottom 5 price movers, NAV movers, highest premiums, largest discounts, highest and lowest yields, and z-scores.

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We extend that to all ~580 closed-end funds and show the same statistics across the entire CEF space.

The largest NAV gainers by sector this week were real estate and taxable munis.

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The largest NAV decliners on the week:

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The largest price gainers on the week:

The largest price decliners on the week:

The top ten funds that saw the most discount change in the last week to the positive side (meaning discount tightening or premia build):

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The top ten funds that saw the most discount change in the last week to the negative side (meaning discount widening):

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Commentary

We have moved from "everything is a buy" to a slightly overvalued position in a relatively short amount of time.  It was only a few weeks ago that EVERYTHING on the Google Sheets was rated "Buy".  We even had 3 "Strong Buys" at the time.  Today, just four positions are rated "Buy" and we have three that are rated "Sell".  This tells me the paradigm has shifted drastically.  While there can be some dislocations in the CEF space, in general, discounts tend to gyrate together.  In other words, discounts tend to tighten in unison and widen in unison.  

Overall, credit is in risk on mode and that is very much apparent in CEFs.  Funds that traded at 10-15% discounts just a couple months ago are now trading near par.  And yet nothing has changed as they have the same risks within them today.  

Let's again look at some pricey CEFs that have run up considerably in the last month.  The taxable bond CEF space is one of the more 'expensive' with z-scores routinely above 1.5 and several above 3.0.  We think this is the time to start lightening up on exposure if you are heavily in "risk on" mode and are aggressively positioned.  Here are some suggestions:

Bancroft Fund (BCV):  This is a fund we've owned for more than a year now and it has been a turbulent time.  Still, the trade has been a profitable one with a total return of over 15%.  Most of this was made during the first three months of last year, then it promptly erased those gains in the fourth quarter.  However, YTD, the fund is up over 13.8%.  The fund is largely tied to the tech sector given most convertibles are issued by tech companies.  At a 9.5% discount, the fund is still trading at a relatively wide absolute discount but is tighter than its 1, 3-, and 5-year average discounts in the 11-12% range.  Much of that discount is likely due to the lower distribution the fund pays (quarterly).

Guggenheim Taxable Muni (GBAB):  This fund has been extraordinary!  In the last 3 months, the total return on price is up over 14%.  As we have noted, this fund has zigged while the market has zagged.  I think investors have recognized that and are adding this high quality fund to their portfolios, regardless of the valuation.  That said, they recently released their semi-annual report that showed some weakness in net investment income.  NII was down to $1.30 annualized, from $1.48 last year.  In addition, they have a likely call wall coming up in the near future (less than 2 years).  We are doing some research (they do not report calls but apparently will be doing so shortly).  For now, we are holding or even taking some small gains.

Other Notes:

Eagle Point Credit (ECC):  This is a popular fund with the retail investor community.  It is a high yield, high risk fund trading at a 28% premium.  The fund only reports its NAV quarterly and in the fourth quarter, saw an 18.6% decline.  Clearly the market believes that given the market rebound, the NAV is going to jump significantly when reported in late April.  That is likely but I do think it's unlikely it jumps by 28% to leave the shares at par.  Plus, things have to stay on the same track as they are now for another 45 days.  It just seems like this is priced for perfection and even then over-valued. 

EV Enhanced Equity Income II (EOS):  This is a fund that has a slight overweight to tech shares and has performed well over long time periods (3-, 5-, and even 10-years).  The fund is up an astronomical 16.4% YTD while the NAV is up 8.6%.  That has resulted in a 6.1% premium and a one-year z-score of +2.20.  The last time the fund was this overvalued, it underperformed the S&P significantly.  


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Those that own it, including myself, may want to consider swapping to similar funds like ETY, SPXX, EOI, and BOE.  From the chart below, you can see that the funds all showed similar performance on NAV over the last six months.  BOE did a bit better given its more conservative holdings and strategy.  

Instead of owning EOS at a +2.20 one-year z-score, you could swap to a fund like EOI which has performed similarly and yet trades at a 3.15% discount and has a -0.40 one-year z-score.  While -0.40 isn't a screaming bargain, it is a lot cheaper than EOS.  

MAV/MHI Distribution Cut

The big news on the week was the cut to the distribution of MAV.  This is something we had anticipated given the material deterioration of the financials.  The alert when out when MAV cut and the price fell sharply.  The price went from $11.05 to $10.46 in four trading days, a decline of 5.3%.  That is well below the 19% cut in the distribution.  The yield is down to 4.88% from almost 5.55%.  We would not be adding here as we've seen discounts widen for over 2 months after a large cut.  

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MHI saw a decline in sympathy but is still near its 52-week average in discount and yielding 5.60%.  We still think a distribution cut is likely coming though the NAV is rising nicely.  For now, better to be safe and cautious and move into better situated funds that are less likely to cut.  

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