CEF Weekly Review: Are discounts good or bad?

Welcome to another installment of the CEF Market Weekly Review. There, we discuss market activity for closed-end funds (“CEFs”) both from the bottom up, focusing on news and events for individual funds, and from the top down, providing an overview. of the broader market.we are also trying We provide some historical background and relevant themes that appear to be driving the market or that investors should keep in mind.

This update covers the period through the second week of May. Be sure to check out our other weekly updates covering the Business Development Company (“BDC”) and senior/baby bond markets for a perspective across the broader income spectrum.

market activity

CEFs have performed well this week, with NAVs across all sectors increasing. MLPs and utilities took the lead. The situation since the beginning of the month is solid, with gains across a wide range of sectors. Both his NAV And discounts supported price increases.

Discount rates for the fixed income CEF sector have been trading near rock bottom over the past year. Equity CEF discounts remain subdued.

market theme

CEF activity has increased in recent months, with asset managers such as Mr. Saba and Mr. Karpas accusing CEF managers of various wrongdoings in an effort to wrest control of the board.

One of the criticisms that CEF activists often level at managers is that the discounts on the funds they cover are too wide. Activists say their presence is evidence that management is mismanaging investors’ capital. But as with anything else, we don’t have to take activists at their word. Let’s take a closer look at this.

Activists’ criticisms are frank. Deep discounts are undesirable because the wider the discount, the lower the price of a particular holding and the value of an investor’s investment account.

However, questions about discounts apply both ways. The wider the discount, the higher the implicit leverage level that investors achieve on their capital. This creates a type of margin dynamic trading without the risk of margin calls. Discounts also extend the underlying yield of an asset portfolio and, if the discount is wide enough, can completely offset management fees, making active management possible at no or very little cost.

Another way to think about CEF discounts is that they are the mathematical result of management fees and secondary market transactions. In other words, because the CEF manager is entitled to a fee on the basket of assets, that basket of assets should trade at a discount to the secondary market value of the fund wrapper. Of course, not all his CEFs will trade at a discount, but that’s because fees are not the only discount factor, it also depends on risk sentiment, fund alpha, leverage costs, and other factors.

CEF activists can use the presence of a discount to suggest that a particular fund has no alpha. This may be true in theory. However, in reality, risk sentiment and recent performance typically overwhelm alpha-related discount trends. One piece of evidence of this is that all 71 of his CEFs in the municipal CEF sector are trading at discount prices. It seems unlikely that there is not even a single fund within this sector with net positive alpha.

This suggests that the mere existence of a discount is not the manager’s responsibility, but rather that the discount is a reality of the CEF structure where the fee annuity is simply capitalized. When a mutual fund trades in the secondary market, it will most likely do so at a discount as well. After all, we can support what his CEF activists are trying to accomplish, but we don’t have to accept their explanation. Their main purpose is to make money, and their moral ostentation is often smoke and mirrors.

Market commentary

BlackRock and CEF activist Saba are working on it. Saba has asked BlackRock to remove it from managing six of its funds. These include BCAT, ECAT, BIGZ, BMEZ, BSTZ and BFZ with total assets of over $10 billion. Saba’s stake in these is 8% to 28%. A proxy meeting is scheduled for late June, and new directors could be elected to decide the fund’s fate. There’s plenty of the usual moral support from both parties. Saba claims that BlackRock is illegally interfering with the selection of candidates, but BlackRock claims that Saba simply wants to hijack funds to generate fees and has already done so several times. It is claimed that

Elsewhere, work in the Muni-CEF field highlighted a few weeks ago is beginning to bear fruit. BlackRock Muni CEF (MUI) at a 2% discount to NAV, provided that the fund can convert into a private interval CEF (i.e. a fund that provides liquidity to investors by regularly purchasing a fixed number of shares). announced that it would hold a tender offer for 50% of its shares. KK.

This is a fairly unusual CEF response to an activity. While we tend to see tender offers, closings, and conversions to open-end funds from time to time, conversions to private CEFs are highly unusual. The main problem with this is that it’s bad news for most of the fund’s current shareholders. They will be less enthusiastic about owning unlisted funds. A potential benefit for BlackRock is that it would make the job of CEF activists more difficult, since it would be difficult to acquire large stakes in private funds.

There are two possible tactical trades here. One is to buy the fund now at about a 7% discount and leave potential upside when half of the shares will likely be repurchased at his 2% discount. The second option is to purchase the fund once the tender offer is complete. At that point, very few shareholders will be interested in owning the company privately (the remaining shareholders will either be strategic traders or simply uninterested shareholders, both of whom will be eager sellers). ). is likely to blow out, creating an attractive, if illiquid, holding situation for long-term buy-and-hold investors. First Trust announced the completion of its MLP Fund merger. Recall that MLP CEF FEN, FEI, FPL, FIF he was merged into ETF EIPI. Although this was a tax-free restructuring, some funds said they needed to make some adjustments to their NAVs (increase FEN, decrease FEI) before merging.

The manager said further NAV adjustments are likely to be made not only for CEF but also for EIPI in preparation for the merger. This likely has to do with deferred tax assets and liabilities, which are unique to MLP CEFs. Merger pitches include: daily portfolio transparency (a small benefit), elimination of discounts (beneficial for existing investors consolidating into an ETF, but less so for new shareholders), and lower total expense ratios. (It was not as high as the EPIPI’s 1.1, which you might think). % management fees – very high for active ETFs and also high for CEFs).