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  Discounts to NAV Indicate Real Value
Posted Under: Discounts • CEFs

 
One important indicator closed-end fund (CEF) investors should use to see if there is value in an individual CEF or value in a specific category of the CEF marketplace is to examine a fund or category's current discount to NAV relative to its historical average. CEFs historically revert back to their mean average discount to NAV so if a fund or category of funds is trading at a wider discount to its historical average discount to NAV it often signals there is value to be had.

While I think CEF investors should examine several factors before investing in a CEF or basket/portfolio of CEFs such as attractiveness of the underlying asset class, sustainability of the distribution, NAV track record, leverage structure and duration/credit quality if it is a fixed income fund, I also think analyzing a fund's current valuation compared to its historical average is an important factor to determine if value exist in that fund.

Based on that last factor, I believe there is indeed real value across several different categories of the CEF marketplace now especially in light of the fact that the Fed has indicated they intend to keep the Federal Funds rate low for an extended period of time which should keep leverage cost very low for most funds. Keep in mind, most CEF's leverage cost is tied to short term interest rates and not intermediate or long term rates. Indeed, as you can see above, many categories of the CEF marketplace are trading at significantly wider discounts than they historically trade at and I think that indicates there is value in many categories of the CEF marketplace.

When long term interest rates started trending higher in May, investors clearly got the message that they needed to be vigilant about interest rate risk in their portfolios. However, based on these much wider than historical average discounts to NAV, the fact that the Fed continues to keep the Fed Funds rate at 0-0.25% and the fact that there are very compelling yields available across many different categories of CEFs, I believe CEF investors may have overreacted a bit by blindly selling their CEF positions almost regardless of the NAV performance and regardless of the valuations and yields their funds provide.

As a result of this selling pressure, many categories of the CEF marketplace are trading at significantly wider than average discounts to NAV and while we have yet to see investors take advantage of these wide discounts and still very high yields, historically when discounts widen this much more than historical averages it usually does begin to attract buyers. Again, while discounts to NAV is only one factor (among many) that I believe investors should analyze when looking at an individual CEF or category of CEFs, I also firmly believe that the present discounts to NAV do indeed indicate there is real value across many different categories of the CEF marketplace and the data above illuminates that point.

The chart is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. An index cannot be purchased directly by investors. Closed-end funds are subject to various risks, including management's ability to meet the fund's investment objective, and to manage the 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. Unlike open-end funds, which trade at prices based on a current determination of the fund's net asset value, closed-end funds frequently trade at a discount to their net asset value in the secondary market. Certain closed-end funds may employ the use of leverage which increases the volatility of such funds.

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Posted on Thursday, August 8, 2013 @ 3:25 PM • 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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