As you might know, I have been an advocate, and continue to be, for closed-end fund (CEF) investors to have exposure to credit sensitive funds and shorter duration funds based on the compelling yields they provide, defaults which remain below historical averages and based on the shorter duration/interest rate risk these funds generally have.
It's been roughly three months since intermediate and long term interest rates began their significant move higher so I wanted to address the share price weakness these three categories have endured the past three months despite their compelling yields, fundamentals and valuations that I believe exist in these categories and why I continue to advocate CEF investors maintain exposure to these three areas.
According to Morningstar over the past three months through 8/15/13, share prices on a total return basis are lower by 9.56 percent for high yield CEFs, 11.71 percent for limited-duration CEFS and 6.31 percent for senior loan CEFs. Based on many calls I have had with investors, I know some investors are surprised and disappointed with these recent results. However, I think it is important to highlight that while share prices of these categories have been lower the past three months, underlying net asset value (NAV) performance has been much better than share price performance. This is important to note because historically while CEFs can be inefficient over short periods of time, as they have been in the last three months with share prices performing much worse than underlying NAVs, eventually share prices do begin to gravitate towards NAVs and discounts to NAV tend to narrow. I wrote about this in my second quarter CEF commentary from 7/17/13 when I discussed how, when we go through these periods of enhanced volatility in CEFs, share prices often sell off much more than NAVs.
Let's now look at the underlying NAV performance of these three categories which I think clearly indicates that the selling pressure we have seen in the share prices of these categories has been overdone. According to Morningstar over the past three months through 8/15/13, NAVs on a total return basis are only lower by 2.04 percent for high yield CEFs, 2.80 percent for limited duration CEFs and 0.04 percent for senior loan CEFs. As the data indicates, the underlying NAVs of these categories have indeed held up much better than share prices and that has caused discounts to NAV to widen out. In fact, as of 8/15/13 according to Morningstar, high yield CEFs are at an average discount to NAV of 5.82 percent, limited duration CEFs are at an average discount of 9.31 percent and senior loan CEFs are at an average discount of 2.10 percent. Please see Blog from 8/8/13 on this subject.
While it is impossible to know when investors will begin to recognize the clear fact that NAVs have held up much better than share prices for these three categories as interest rates on the long end have trended higher, eventually I believe investors will begin to recognize the value and that the underlying asset classes these categories focus on are compelling based on the yields, fundamentals, limited duration risk and valuations.
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Posted on Friday, August 16, 2013 @ 4:48 PM