With all of the volatility in fixed-income closed-end funds (CEFs) the last four months, it may have been overlooked that one category of the CEF marketplace which continues to perform well and remains one of two categories I have had the highest conviction level in since January 2012, is domestic equity CEFs. (Senior loan CEFs is the other category I have had the highest conviction level in since January 2012.) Indeed, year-to-date (YTD) through 9/13/13, the Morningstar universe of 119 domestic equity CEFs is up 9.44% on a share price total return basis. The same universe is up 12.71% on a net asset value (NAV) total return basis.
My thesis for liking domestic equity CEFs has been centered around five key factors including: strong fundamentals for domestic equities, a market multiple which is below historical averages, compelling yields among domestic equity CEFs, modest growth in the U.S. economy and wider than average discounts to NAV available among the universe of 119 domestic equity CEFs. Despite very solid performance for domestic equity CEFs the past couple of years, it still remains a category I have a high conviction level in as I believe all five of these key factors remain in place.
While the U.S. economy may not be booming, it is growing modestly (2nd quarter GDP growth was 2.5%) and that coupled with strong corporate balance sheets and global growth should help propel earnings per share (EPS) growth for the S&P 500 Index to 6.02% in 2013 and 10.87% in 2014 according to Bloomberg. Furthermore, even with the 18.36% increase in the S&P 500 index YTD through 9/13/13, according to Bloomberg the S&P 500 trades at an estimated P/E multiple of 13.74 based on 2014 EPS estimates. This is below the 20 year average P/E multiple of 19.66 and the 50 year average P/E multiple of 16.53.
Furthermore, as of 9/13/13, according to Morningstar the universe of domestic equity CEFs is trading at an average discount to NAV of 6.16% which is wider than its one year average discount of 4.22%, its three year average discount of 3.57% and its ten year average discount of 3.43%. Lastly, the average distribution yield among all 119 domestic equity CEFs remains a compelling 7.09% as of 9/13/13 according to Morningstar.
In short, based on the continued positive fundamentals of the underlying asset class of domestic equities, compelling valuation in the asset class as well as the CEF structure, an economy which continues to grow modestly and yields which remain attractive, I still believe domestic equity CEFs should be part of a diversified CEF portfolio.
Past performance is no guarantee of future results. 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.
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.
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