5 Closed-End Fund Buys In The Month Of January 2024 (Includes 2 Swaps)

The market has taken a pause as we enter the new year, leading to fairly mixed results for U.S. equity sectors in January. The latest hot CPI report certainly adds more uncertainty going forward as well.

Interest rate-sensitive sectors such as utilities and real estate saw higher risk-free rates, making them less appealing. This was after November and December treated the space well when Treasury Rates were falling on the back of the Fed, signaling a pivot.

That said, the broader market, as measured by the S&P 50 Index, was still hitting record highs throughout the month as well. In the last month, it was still able to eke out some gains overall.

I try to do a bit less buying after such strong runs and when the broader markets are hitting all-time highs. Admittedly, this market is a bit unique in that the Magnificent 7 names primarily drove it. Though with Tesla (TSLA) faltering, the club may be shrinking to just 6. When looking at some of the equal-weighted ETFs’ performance, we see a bit of a different picture. They still have very respectable returns but are significantly below those ETFs that track the market-weighted indexes.

With all this being said, every month, I still do some buying. That’s even if it’s a bit less, and I allow some cash to build up. As long as the Fed hasn’t cut yet, cash is still paying a pretty attractive rate of ~5%, so holding cash these days is not necessarily a bad thing either.

Nuveen AMT-Free Municipal Value Fund (NUW)

This month, I kicked the buying off by picking up some more shares of NUW, which was actually the same thing that I did in December as well. I very recently posted an update on this fund that discusses it more in-depth. The main logic is summed up from my original post:

[Western Asset Investment Grade Income Fund (PAI)] is a non-leveraged investment grade fund, and NUW is a municipal bond fund that is very lowly leveraged. NUW limits itself to 10% leverage, but is generally even below that. Currently, they list $2 million in borrowings, coming to an effective leverage ratio of 0.73%.

Without being leveraged essentially for both of these names, the moves to the downside are relatively limited. Of course, the moves to the upside can also be limited when times are good.

So in going a non-leveraged route, it’s taking more of a tepid way to play the potential end to interest rate hikes. If rates are cut, the upside on these could be limited relative to their leveraged peers. On the other hand, if rates continue to go higher as expected, the downside should also be limited.

These are long-duration fixed-income assets, so they are incredibly sensitive to higher interest rates. The average effective duration for NUW is 8.08 years. The effective duration for PAI comes to 7.29 years.

Being non-leveraged or low leveraged also meant that they didn’t experience rising interest rate costs on borrowings that many other funds did. This played out in the muni space by seeing most leveraged funds cut, cut, cut and then cut their distributions again.

It was a bumpy year for rates, but so far, these positions have left me with some small gains and some small distributions on top of that.

Ecofin Sustainable and Social Impact Term Fund (TEAF)

The next purchase I made was to add to another position in my portfolio. I also quite recently covered this fund in more depth. The main lure here is that it is a term structured fund, and it is trading at a substantial discount. The term is quite far off – but if the fund does liquidate as intended (this isn’t guaranteed) – then it actually shows an annualized alpha of 3.15%. That’s even though the term isn’t due until March 2031, but the discount is so large that it is meaningful enough.

Whether or not this is ultimately realized, only time will tell. The portfolio primarily consists of private investments in clean energy projects/ideas, as well as even social infrastructure projects such as education and senior care facilities.

Ultimately, I believe it’s a riskier fund that most likely isn’t for most investors. That’s probably why it is trading at such a substantial discount in the first place. I’m willing to take the gamble, though.

Eaton Vance Tax-Managed Buy-Write Opportunities Fund (ETV)

I added to my position in ETV this last month as well. This is a fund that historically had enjoyed quite a lengthy period of trading at a premium. The fund maintained a level distribution rate for many years before it ultimately cut its payout in 2022’s bear market. That scared investors away, and now it trades at a massive discount.

I’m not sure if the fund will ever reclaim the glory days of a premium, but you’re actually getting some general market exposure with a call-writing strategy on top. So I’m not too concerned overall, anyway. Even if the fund doesn’t reach a premium again, the performance should be respectable over the long term.

The fund invests with a focus both on the S&P 500 and Nasdaq 100 Indexes. That pushes the fund’s portfolio heavily in the tech space and the Mag 7(6?). They then write call options against these indexes to pocket the premium and ultimately deliver what should be a higher distribution rate to investors. However, like any call-writing strategy, it can limit some of the upside in a strong up market. For ETV, they overwrite at nearly 100% of their portfolio, with the last % out of the money listed at 4.6%.

Flaherty & Crumrine Total Return Fund (FLC)

This purchase was more of a swap with a little bit of new cash thrown in. I was looking to add to one of the Flaherty & Crumrine funds, and I already held the Flaherty & Crurmrine Dynamic Preferred and Income Fund (DFP). However, it was FLC that was the cheapest and most discounted of the group of similar F&C funds at the time of the transaction. That is still the case at the time of writing, and it is also well below where these funds had been trading at in terms of discount/premiums.

These funds have identical investment policies and end up being invested quite similarly. This results in a significant correlation between the funds and makes them good swap candidates.

With that said, instead of adding another fund to my portfolio, I swapped DFP in favor of FLC while adding more exposure through some fresh cash. The idea here is somewhat similar to why I had been adding NUW and PAI but a more aggressive and potentially more lucrative opportunity.

The F&C funds are leveraged, and they aren’t hedged against the higher rates either. That means that they can not only benefit from risk-free rates declining, but when the Fed does cut, their borrowing costs should ease quite quickly. If they are spending less for borrowings, then we could be in a position to see NII rise quite quickly, too – basically, the reverse of what we had been seeing play out over the last couple of years with many cuts to the distribution. The average coupon of the FLC portfolio was listed at 6.94%.

Their borrowings are paid at a rate of SOFR plus 0.90%. SOFR, as of this writing, stands at 5.31%, leading to the borrowing costs for FLC to come to 6.21%. That means they are, on average, barely earning a positive spread above their borrowing costs. Then you throw on top of that an investment management fee of nearly 1% and operating expenses of another 0.48%, and the spread becomes negative. Of course, that’s only on average; now, with some floating rates kicking in and some of their lower-quality holdings paying 10%+, it could be argued they are benefiting from the leverage on those types of holdings.

Some evidence of rate stabilization already taking place was reaffirmed as they raised their distributions with the latest announcements, too. They could have raised because they cut too aggressively and now are earning excess NII. It could also be that some of their fixed-to-floating rate preferred are starting to kick in as well.

Last year, my main focus was on deleverage and de-risk. FLC is a highly leveraged fund, but was also mostly a swap from DFP to FLC, which are equally as leveraged up. Additionally, as laid out above, if rates drop as expected, that will turn what was a headwind into a tailwind. For this reason, I’ll probably be a bit more liberal in terms of what funds I’ll be willing to add and less focused on the deleverage emphasis than I was last year.

Cornerstone Strategic Value Fund (CLM)

To close out the month, I ended with another swap on the more tactical side of the spectrum. In this case, I sold out of my Miller/Howard High Income Equity (HIE) position to make room for CLM.

This was more of a difficult decision, and it took me a couple of weeks to push myself to do it. HIE is actually a term fund that is set to liquidate later this year. The fund has already deleveraged, which suggests they may not try anything too fancy to get around it. That said, since the fund still carries around a 4% discount and we have less than a year, the annualized alpha comes out to 5.6%. That’s still pretty good.

That said, CLM’s valuation has come down significantly in the last several months – even as the market made a massive push higher from the Fed pivot that brought up the fund’s underlying performance. When I made my move, it was a little ironic that I sold HIE at around a 4% discount and picked up CLM at a 4% premium.

For those unfamiliar, CLM is essentially the S&P 500-like exposure but with the twist that they pay a 21% managed distribution policy. Of course, everyone knows they won’t earn that every year, and that will result in the NAV declining and lower distributions over time.

Still, the fund, as seen above, generally commands a strong premium regardless. Which means it’s a bit similar to the rationale for adding to ETV. It’s at a good historical valuation, but only time will tell if it commands a higher premium ever again. These levels could be the new normal trend or possibly even lower. At the end of the day, though, you are investing in pretty much the ‘market’ with a couple of twists.

The premium is a part of the attractiveness as well due to its fairly unique policy. For CLM, investors can reinvest at the NAV rather than limiting to a 5% discount to market price when trading at a premium that the vast majority of other sponsors have in place. RiverNorth is the only other fund sponsor I know of that allows for reinvesting at the NAV when trading at a premium.

So, with that said, one should always reinvest when the fund is trading at a premium – even if they want cash, they can turn around and sell the shares higher on the open market themselves. That’s why a higher premium is actually better for investors in the fund, and actually, the higher, the better.

Another point I considered when swapping HIE to CLM is that they generally have some high correlation. The actual end results have been vastly different, with CLM being able to participate in much more upside due to the growth tilt that the S&P 500-esque fund carries. For HIE, they are mostly value- and dividend-oriented investments that have been ‘struggling’ on a relative basis for most of the last five years. 2022 was an exception where HIE produced positive results thanks to its even more particular emphasis on energy investments.

HIE has a good chance of producing some highly guaranteed annualized alpha from here if it liquidates later this year; that said, it doesn’t guarantee positive results. If we get a market crash, both CLM and HIE should be negatively impacted if that general correlation trend continues. However, these two funds are far from what would be called a “perfect swap pair.”

I’m not specifically looking for a crash in the market; I don’t try to make those types of calls at all. On the other hand, it is hard to ignore that we have moved pretty quickly to the upside, and that’s pushed the SPDR S&P 500’s (SPY) relative strength index (“RSI”) to over 70 now. In fact, it has been hovering there for the last few months now. That indicates overbought conditions. So, some sideways movement or heading a bit lower from here wouldn’t be unexpected.

Which I believe is the main risk to the tactical play of picking up some CLM shares at this time. The fund could go back to a higher premium, but that doesn’t have to happen with the share price rising. It could just as easily come from the fund’s underlying portfolio declining and pushing the NAV lower.

Additionally, I was sitting on a 40%+ (not counting distributions) gain for HIE, too, due to picking up most of my position during the Covid pandemic. I thought it was a decent time to take those profits home.

In the case of this swap that I made, I also put some additional cash to work as well. As I plan to participate in the DRIP, the position should grow every month. I plan to take it on a month-by-month basis on what I intend to do with those DRIP shares, whether to hold on to them or liquidate them for cash.