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Jeff Margolin
Closed-End Fund Analyst
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  Senior Loan Closed-End Funds off to a Strong Start in 2015
Posted Under: CEFs
After a challenging 2014 when the average senior loan closed-end fund (CEF) was lower by 1.93%, senior loan CEFs are off to a strong start in 2015. Indeed, the average senior loan CEF is up 5.53% year-to-date (YTD), which makes the senior loan CEF category one of the best-performing taxable fixed-income categories within the Morningstar universe so far this year. By comparison, the average taxable fixed-income CEF is up 2.91% YTD. (All data is from Morningstar on a share price total return basis through 3/25/15.)

I believe there are a few key reasons for the strong start to the year for senior loan CEFs including:

1. Investors are starting to recognize and take advantage of the compelling valuations as well as compelling fundamentals that exist in the senior loan asset class and senior loan CEFs. While many fixed-income asset classes trade on average above par, the average senior loan as measured by the S&P/LSTA U.S. Leveraged Loan 100 Index is trading at a slight discount to par. According to Bloomberg, the average senior loan price was 96.16 as of 3/25/15. Moreover, while average discounts to net asset value (NAV) have narrowed to 6.32% as of 3/25/15 from the 9.09% they ended 2014, according to Morningstar, they are still wider than historical averages. One year ago the average discount to NAV was 5.22%, three years ago the average discount to NAV was 0.66%, five years ago the average premium to NAV was 3.27%, and 10 years ago the average discount to NAV was 0.79% (Morningstar as of 3/25/15). Lastly, fundamentals continue to be sound with the default rate by number of loans falling to 0.73% in February from 0.75% in January, according to Standard & Poor’s.

2. Investors are in the very early stages of repositioning their fixed-income portfolios to shorten durations ahead of a potential increase in the federal funds rate later this year.

While just under three months does not make a long-term trend, it has been encouraging to see share price momentum build in senior loan CEFs in 2015, particularly after a difficult 2014. Based on the continued strong fundamentals in the senior loan asset class, compelling valuations among senior loan CEFs and the senior loan asset class, I continue to believe senior loan CEFs should be part of a diversified CEF portfolio. Please see my CEF Quarterly Commentary from January for further comments on senior loan CEFs as well as other categories I currently favor. Click here to view.
Posted on Monday, March 30, 2015 @ 10:29 AM • Post Link Share: 
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  Two Trillion Dollars and Counting…
Posted Under: ETFs

2014 was a record-setting year for US-listed ETFs, with assets exceeding $2 trillion by year end, according to Morningstar.  This increase of approximately 18% versus the end of 2013 was fueled by record net inflows, which totaled an estimated $241.9 billion.¹ As usual, ETF net flows were not equally distributed among major asset categories.  Results for the fourth quarter were generally in line with the full year, as 3 of the top 4 categories for inflows were equity-related (US Equity, Sector Equity, International Equity), while the Taxable Bond category received the second most inflows during the fourth quarter and the full year.  Also following the trend established during most of 2014, the Commodities ETF category had the largest net outflows.

Click Here to continue reading.

¹Morningstar Direct. Includes all US-listed exchange-traded funds, exchange-traded notes and other exchange-traded products.

Posted on Tuesday, February 17, 2015 @ 1:48 PM • Post Link Share: 
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  Technology Dividends — A Missing Ingredient in Your Equity Income ETF
Posted Under: ETFs

Over the past 5 years, few themes have more consistently resonated with ETF investors than equity income.1 Since 9/30/2009, equity income ETFs have collectively gathered over $50 billion in net inflows, with positive net inflows in 19 out of the last 20 quarters.2 This recent popularity can largely be attributed to investors’ growing appetite for income in a yield-starved interest rate environment, combined with the perception that dividend-paying stocks may be less risky than non-dividend payers.

As we’ve discussed in previous newsletters, however, one of the risks that investors face with equity income ETFs is sector concentration.  While there is nothing inherently wrong with overweighting certain sectors while underweighting others, large sector bets may produce unexpected or undesirable results.  For example, on 9/30/08, just before the collapse of the financial services sector, equity income ETFs allocated an asset-weighted average of 42.6% to financial stocks, representing a 26.6 percentage point overweight relative to the S&P 500 Index.3 Unfortunately for investors, financial stocks suffered extreme negative returns over the next 6 months.  Interestingly, the financial sector is currently the second most underweight sector within equity income ETFs, relative to the S&P 500 Index.4 Conversely, utilities and consumer staples are the two most overweight sectors within equity income ETFs, with average allocations 8.1 and 7.0 percentage points higher than the S&P 500 Index, respectively.5

Click Here to continue reading.

¹Included in this group are non-sector US equity ETFs whose names suggest a “dividend” or “income” strategy.
²Morningstar Direct, as of 9/30/14.
³Morningstar Direct.  As of 9/30/14, there were 17 US listed equity income ETFs.  ETF AUM-weighted average sector allocation is used in this comparison to best represent the sector allocation of most investor dollars.
4Morningstar Direct, as of 9/30/14.
5Morningstar Direct, as of 9/30/14.

Posted on Tuesday, February 17, 2015 @ 1:46 PM • Post Link Share: 
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  Fourth Quarter 2014 CEF Review
Posted Under: CEFs

2014 was a solid year for diversified closed-end fund (CEF) investors. I specifically use the term “diversified” because whether I am writing about CEFs or giving a presentation about the CEF structure, I always encourage investors to diversify across several different categories of the CEF structure in order to attain proper diversification and exposure to many different asset classes. According to Morningstar, the average CEF was up 7.88% last year on a share price total return basis. As always, performance varied significantly depending on the category.

For example, two of the categories I advocated investors have exposure to in my commentary a year ago posted solid total returns. The decline in long-term interest rates, coupled with continued very low leverage cost, was particularly beneficial to long-duration municipal CEFs. Municipal CEFs were up on average 17.80% on a share price total return basis in 2014. Many equity-oriented CEF categories also performed well in 2014, particularly equity funds with an emphasis on U.S. equities. Indeed, according to Morningstar, the average domestic equity CEF was positive by 6.10% on a share price total return basis.

Click here to continue reading.

Posted on Monday, January 26, 2015 @ 10:36 AM • Post Link Share: 
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  Senior Loan & High Yield Review – 4th Quarter 2014
Posted Under: Senior Loan

2014 proved to be far more eventful than most predicted. Consider the nearly certain prognostication that rates would increase in 2014, the surprising impact the polar vortex had on economic activity early in the year, geopolitical headlines Russia/Ukraine, Middle East [Gaza, ISIS], Europe [Greece], etc.), Ebola fears, and last, but most certainly not least, the nearly 50% drop in the price of oil (more on this in a moment). As a result, while sentiment was relatively positive in the early part of the year, investor sentiment for credit risk reversed course and was relatively weak throughout the second half of the year.

In the third quarter, we wrote about how we believed the “risk sentiment” shift was driven by technical factors (more sellers than buyers) rather than fundamentals. Our view has simply been that the U.S. economy continues its slow, yet relatively steady march higher (with improvements in GDP and unemployment) and corporate credit fundamentals remains healthy (with modest corporate defaults and healthy profits). Indeed, the U.S. economy has proven resilient, and even surprising to many with better growth in the latter part of the year. However, despite what’s occurring in the U.S., macro uncertainty continues to incite volatility in U.S. financial markets. As we enter 2015, oil will remain in the headlines given that its collapse will pressure economies that are heavily dependent on crude oil exports. The concern centers on whether we’ll have an emerging market debt and currency crisis similar to that which we experienced in 1998 (when Russia defaulted on its debt). In addition, all eyes are going to be directed at whether the European Central Bank’s (ECB) stimulus program (its own version of QuantitativeEasing) is enough to improve the Eurozone economy. Speculation is already mounting regarding the potential size and scale of such stimulus.

For a discussion of notable events in the senior loan and high-yield market as well as an outlook for the future, click here to read the whole report.

Posted on Wednesday, January 21, 2015 @ 3:50 PM • Post Link Share: 
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  Senior Loan & High Yield Quarterly Review
Posted Under: Senior Loan • High Yield

For the first time in quite a while, a healthy dose of volatility was introduced into various markets of risk assets, including equities, senior loans and high yield bonds. The volatility was driven largely by geopolitical headlines, including Russia/Ukraine, Gaza, Banco Espirito Santo bailout, Argentine default, etc. As a result, risk sentiment reversed course, and investors became more defensive in the quarter. Moreover, importantly for fixed income investors, with the Federal Reserve’s (the “Fed”) unprecedented stimulus program approaching the finish line, investor attention began to shift towards 2015 and the timing of the first interest rate increase. The Federal Reserve bond buying program will be reduced to just $15 billion per-month in October, from a peak of $85 billion per month, and is widely expected to conclude at their next meeting at the end of October. On August 28, the 10-year Treasury bond yield reached a one-year low, closing at 2.34%, well below the 3.03% at the start of the year. Rates have indeed been volatile, as evidenced by the fact that by mid-September, the 10-year Treasury yield moved above 2.60%.

We note that much of the credit market volatility in the third quarter, whether senior loan or high-yield bond related, has been technically induced, simply meaning that there have been more sellers than buyers given the sudden shift in risk sentiment. This technical selling pressure, when coupled with low corporate default rates for senior loan and high yield bond issuers and stable/improving corporate profits, suggests that this is merely a healthy dose of volatility which should lead to opportunities for patient investors.

For a discussion of notable events in the senior loan and high-yield market as well as an outlook for the future, click here to read the whole report.

Posted on Monday, October 13, 2014 @ 4:04 PM • Post Link Share: 
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  Early Thoughts on Tax-Loss Selling Season
Posted Under: Yield • Discounts • Income • Municipal • Equity

Jeff Margolin • Senior Vice President • Closed-End Fund Analyst

With the fourth quarter about a week and a half away, the topic of tax-loss selling and closed-end funds (CEFs) is one that is often on the forefront of CEF investors’ minds. Tax-loss selling is when investors sell securities to realize losses in order to offset gains within their portfolios. Tax-loss selling in the CEF structure often is most pronounced from roughly mid-November to the third week of December. It can lead to enhanced volatility and discounts to net asset value (NAV) widening during this period. The share price weakness and discount widening from tax-loss selling tends to be a short-lived, technical phenomenon that historically reverses course at the beginning of the following year when discounts to NAV often narrow and bargain hunters look to take advantage of the discounts and opportunities that were created during the previous quarter’s tax-loss selling.
Historically, tax-loss selling is most prominent during years in which the total returns for the majority of CEFs and categories within the CEF structure are lower for the year and therefore CEF investors have losses to take. With the average CEF up 9.65% year-to-date (YTD) through September 19th (according to Morningstar) on a share price total return basis, it has clearly been a positive year for the average CEF in 2014. Moreover, not only is the average CEF return positive by nearly 10% YTD, but it has also been a very broad rally with almost every category of the CEF marketplace positive for the year. Indeed, according to Morningstar, Emerging Markets is the only broad CEF category with a negative share price total return with the 18 CEFs in this category lower on average by 0.77% YTD, as of 9/19/14.

While a lot can change between now and the end of the calendar year, based on the fact that most CEFs have produced positive share price total returns so far in 2014, I believe conditions do not appear likely for there to be a lot of tax-loss selling in the CEF structure this year. However, it is important to state that while the CEF structure might not experience significant tax-loss selling in the fourth quarter, I believe there is still the possibility for some enhanced volatility as investors potentially begin the process of repositioning CEF portfolios ahead of 2015 when the Federal Reserve could finally begin to increase the Federal Funds rate, which has been at 0-0.25% since December of 2008. Also, while this has been a very solid year from a share price total return perspective for most CEFs, it does not mean CEF investors do not have losses in individual CEFs they have owned for more than a year, and therefore could still be candidates for tax-related selling. Either way, my primary focus as the fourth quarter commences is to continue to be an active proponent of CEF investors utilizing a four part “game plan” focused on adjusting CEF portfolios ahead of the potential increase in the Federal Funds rate that I outlined in this commentary piece from July 24, 2014: Click here to view 7/24/14 commentary.

Unlike open-end funds, which trade at prices based on a current determination of a fund’s net asset value, closed-end funds frequently trade at a discount to their net asset value in the secondary market. Not all closed-end funds invest in income-producing securities and there is no guarantee that a fund’s yield will not fall regardless of whether the discount widens. In addition, as an investor’s total return will be impacted by the value of the fund’s shares, a widening discount will negatively affect total return.
Closed-end funds are subject to various risks, including management’s ability to meet a fund’s investment objective, and to manage a fund’s portfolio when the underlying securities are redeemed or sold, during periods of market turmoil and as investors’ perceptions regarding the funds or their underlying investments change. Certain closed-end funds may employ the use of leverage which increases the volatility of such funds.
All opinions expressed constitute judgments as of the date of release, and are subject to change without notice. There can be no assurance forecasts will be achieved. The information is taken from sources that we believe to be reliable but we do not guarantee its accuracy or completeness.

To Download a PDF of this post, please click here.

Posted on Wednesday, September 24, 2014 @ 2:34 PM • Post Link Share: 
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  Seeking Alpha with Biotechnology ETFs
Posted Under: ETFs
2014 is shaping up to be another strong year for the biotechnology industry and associated exchange-traded funds (ETFs). After declining nearly 20% from February to April, the NYSE Arca Biotechnology Index rebounded to new highs during the month of August, boosting year-to-date returns to 34.6% (through 8/31/14). As in years past, the industry's news flow contained a number of important announcements that significantly impacted near term returns for biotechnology stocks. While such stories have a tendency to frame investors' conceptions of biotechnology ETFs in terms of short-term, tactical trading opportunities, a compelling case can also be made for longer-term, strategic allocations to the biotechnology industry.
 
In many respects, biotechnology is unlike other industries. To a large extent, future earnings for these companies depend on innovation that pushes the boundaries of scientific understanding. On the one hand, tremendous resources can be expended on ventures that ultimately provide little or no payoff; on the other, scientific breakthroughs may create blockbuster revenue streams. Moreover, circumstances that are largely beyond the control of biotechnology companies, such as decisions made by regulators, can make or break a project.
 
Click here to continue reading.
Posted on Thursday, September 11, 2014 @ 1:45 PM • Post Link Share: 
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  Municipal Market Update - 2nd Quarter 2014
Posted Under: Municipal
Late last year, while many municipal market participants were predicting a second straight year of negative total returns for municipal bonds in 2014, we called for positive total returns for the full year while recommending that investors focus their attention on the intermediate portion of the yield curve and emphasized an investment orientation in lower investment grade rated bonds. Through the first half of 2014, the Barclays Municipal Bond Index returned 6.0%, including a positive 2.59% during the second quarter of 2014. The Barclays Revenue Bond Index and Non-Investment Grade Index sported even higher total returns of 6.59% and 7.53%, respectively. The FTA High Income SMA generated a total return, net of fees, of approximately 7.33%.
 
So what happened? What accounts for such strong year-to-date performance?  Click here to read the 2nd Quarter Municipal Update.
Posted on Friday, July 25, 2014 @ 5:43 PM • Post Link Share: 
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  Senior Loan & High Yield Review - 2nd Quarter 2014
Posted Under: Senior Loan • High Yield
During the second quarter of 2014, an accommodative Federal Reserve (the "Fed"), strengthening economic data and declining interest rates helped drive returns for equities and longer duration fixed-income assets. Investors continued to scrutinize the rhetoric from the Fed, attempting to gauge the potential pace and timing of prospective interest rate increases. The Fed’s bond buying program is now less than half of the $85 billion-per month program that it was at its peak, and as of the time of this commentary, the Fed has announced the nearly imminent completion of its bond buying at its forthcoming meeting in October.

Much like the first quarter of 2014, the return of leveraged loans, and to a lesser extent, high-yield bonds, underwhelmed relative to other, more rate sensitive, traditional fixed income asset classes in the quarter. As the yield on the 10-year treasury fell 19 basis points from 2.72% to 2.53% during the quarter, it should come as no surprise that longer-duration fixed-income assets were the strongest performers. However, as steadily improving economic data continues to surface, we continue to believe the Fed will have the motivation they require to complete the quantitative easing program and begin the process of raising rates. In the interim, with short-term interest rates remaining at all-time lows and corporate profits healthy, we maintain our positive outlook for the senior loan and high-yield markets.

For a discussion of notable events in the senior loan and high-yield market as well as an outlook for the future, click here to read the whole report.
Posted on Thursday, July 17, 2014 @ 8:30 AM • Post Link Share: 
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These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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The Other Discount Advantage
Municipal Closed-End Funds: MNCEFT Closes Above 1600; Silent Rally Continues
Commodity ETFs and the Business Cycle
Year-To-Date Performance of Municipal Closed-End Funds Shows the Importance of Balance
Mid-Quarter Update: Good Start to 2014 for Many Categories of CEF Marketplace; Still Compelling Values Available
Preparing for the Unexpected with Commodity Futures ETFs
The Power of Closed-end Fund Distributions
Following Solid December, Municipal CEFs off to Good Start in 2014
Senior Loan CEFs: Big Disparity Between Share Price and NAV Performance in 2013
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