We have just passed through the halfway mark of the fourth quarter and are in the thick of the tax loss harvesting season. This occurs with ETFs and mutual funds, however, CEFs seem to be more susceptible than the former two to tax loss selling, especially when the fund trades at a discount.
If the price on a CEF underperforms relative to the NAV, the discount will widen out. This gives the investor the incentive to sell and realize the loss. As more and more investors do this, it exacerbates the situation, creating a self-fulfilling loop.
This tax loss harvesting has been most prevalent during the 45 day period between November 1 and December 15, but can start as early as October 1 and extend through the Christmas holiday.
The "January Effect"
As more and more investors sell shares, they widen the discount further. This creates an opportunity for investors to purchase shares in the latter part of the fourth quarter (early-December to mid-December is the typical purchase range) at unnatural discounts.
The January Effect is where that unnatural discount is closed during the month of January, creating a short term capital gain. This phenomenon has occurred in 16 of the last 20 years.
So investors can take advantage of this temporary mispricing in the CEF market and pick up shares in late November/ early December and ride through January as the discount reverts.
And large, recent price drops in November may lead to greater opportunities as more investors use tax loss selling strategies to realize these losses for the 2018 tax year. This leaves those who want to take advantage of the January Effect a greater possibility to realize gains as discounts reversion takes place in the early part of the new year.