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CEF Insights Quarterly Review
January 2024 Interview – Tom Roseen
CEFA:
Welcome to CEF Insights, your source for closed-end fund information and education, brought to you by the Closed-End Fund Association.
Today, we are joined again by Tom Roseen, Head of Research Services with LSEG Lipper, and author of the Fund Market Insight Report, which provides in-depth monthly commentary on the closed-end fund market.
We’re happy to have you with us today, Tom.
Tom Roseen:
Diane, thanks for having me. Great to be here.
CEFA:
Tom, you recently published your report for December 2023, which covers over 600 closed-end and interval funds. How did investment markets generally perform in the fourth quarter of 2023? And, what was the impact on closed-end funds?
Tom Roseen:
Well, we all know that it was actually a pretty spectacular quarter, but I think we need to put a caveat on that to understand how we got here.
When we’re looking at October, October was not a really good month because we were in this transition period, where the Fed was saying, “Maybe we might pause, maybe we might skip.” People were still very concerned. We still had pretty high inflation rate coming around. When in fact, let me give you the perspective of how the Fed drove this market.
As of January 1st, 2023, the 10-year treasury was at 3.79%. By the time we got to September, it was 4.59%, so we had a pretty big jump. And actually, we peaked at almost 5% for the 10-year treasury, which came in about 4.98% on October 19th. People were still a little bit concerned during the month of October. But again, we were hearing a little bit more dovish conversations from Fed officials, whether it be from the Fed chair, or whether it was Fed governors around. They were talking about, “Yes, we can probably skip. Maybe we can slow down. We’re seeing a little disinflation going on.“
That was also nestled into the fact that, actually, the Q3 earnings report, which came in in Q4, actually beat expectations. Mind you, they were lowered expectations, but they were really good. But, guidance was poor. People were a little bit concerned in October, but the party really started to pick up as we saw these interest rates start coming down. By December 29th, we saw 10-year treasury come in at 3.88%, a 71 basis point drop. This was really the tailwind, if you will, for the markets doing well.
Let’s take a look at this. First of all, we do know that the yield curve was still inverted. That means that the 10-year treasury was basically lower than a two-year treasury. What we saw is that we had about a 35 basis point negative relationship. Normally, we expect 10-years to be longer than the two-year, and that was vice versa. We saw some pretty big numbers. In fact, at the short end of the curve, the two-month was the highest yield you could get. At the end, it was 5.59%. The 10-year, as I said, it closed at 3.88%.
We still have concerns of a recession, but the NASDAQ was up for the quarter 13.56%. Russell 2000, as people were saying, “Interest rates are coming down, small caps might come into vogue,” they were up 13.56% as well. Dow turned a nice 12.48% return. S&P came at 11.24%. But mind you, this is where a little concern goes on, the NADAQ finished the year at 43.42%. Mind boggling, great blowout returns.
What helped this market though, helped us get these returns is we saw oil prices come down for the quarter, about 5.67%. Because of the safety issue, we saw that gold was up about 1.19%. But really, the tech rally, the Mag Seven as everybody’s talking about, really did the job of keeping people in the role. But fortunately, we saw some rotation into other sectors that actually did well.
So again, if you asked me what the quarter did in October, we were at zero, or basically positive in some of the classifications. But as we took a look, closed-end funds entered the area and got into positive territory. This is on NAV basis, so we’re going to do this on net asset value basis. Not on the market prices, but on the NAV. Closed-end funds basically returned, on the equity side, about 7%. And fixed income funds returned about 7.36% for the quarter. So it was really, really strong.
On the year, if we take an overall look, not as handsome as the NASDAQ and not as handsome as the Russell. But you got to remember, we’re put in a lot. We’re putting real estate sector focused funds in there. Equity funds were up 9.69%. Fixed income funds were up 10.73%. So overall, the market’s set up for a very strong return for the quarter for closed-end funds.
CEFA:
Your data breaks out closed-end funds into over 20 classifications. What classifications were the best performing for the month of December, and which sectors struggled?
Tom Roseen:
Well, after my answer to your last question, let’s put it in perspective. Because I’m going to throw a whole bunch of numbers out, and I really don’t want to confuse it.
The average equity fund, average equity closed-end fund, had a 3.42% return for December. Very strong. Not as high as November. November was gangbusters, by the way. But a very strong 3.42% for a month is absolutely spectacular.
But let’s take a look at the macro groups first, of equity funds. Equity closed-end funds in the mixed asset space, this is usually something that has both fixed income and equity in it. In particular, when we’re taking a look at that, we’re really looking at option or arbitrage option strategy funds, convertible security funds and those type of funds. Mixed asset funds for the first month in three outperformed all the other equity macro groups, 4.46%. Then, came world equity funds, they returned about 4.14%. And domestic equity funds returned 2.89%. That was a very strong return for the macro groups.
Now, if we take a look at the average fixed income closed-end fund, they had about a 3.13% return for the month. Again, that’s spectacular for a month. Here’s where the story is quite changing from when we’ve talked about these in the past. November, municipal bond funds were spectacular, 11.04%. But in December, they remained the best, top-leading macro group in fixed income closed-end fund universe, returning 3.79%. So a really, really good two-month period for munis. World bond funds returned 2.98%. And domestic, taxable fixed income returned 2.77%.
The reason I wanted to give the perspective is if I just go to the classifications right away, I think we lose the big trend that we’re trying to take a look at. On the equity side, developed market closed-end funds returned 8.81%. Top performing of the classifications in the equity universe. Followed by, and I mentioned it as far as being one of the mixed asset funds, convertible security closed-end funds had a 7.34% return for December. And the sector equity funds returned 4.57%. At the bottom of the barrel, and that’s where I was going with the energy MLP funds, they had the only negative return in the equity universe for the month. 1.64% decline.
Now, if we take a look at fixed income classifications, we saw emerging market debt, hard currency debt funds for the first month in five rise to the top, returning about 5.47%. High yield leveraged funds returned 4.20%. Here’s where the munis start coming in, but I’ll stop. I could ramble on. New York muni closed-end funds had the best return in the municipal universe, at 4.10%. So really good, overall.
CEFA:
The last six to eight weeks of the year, we sometimes see significant tax law selling in the closed-end fund space. Was this the case in 2023?
Tom Roseen:
We probably saw some in the six to eight week period. We actually saw some people probably take some of those hard won profits they had before we started going into some of the decline in that first part of the quarter and last part of the previous quarter. We probably saw some people take hard won profits off the table where they were putting back into money market funds, or whether they were putting it back into CDs, or just going to different allocations. But we probably did see the typical tax loss harvesting right at the end of the year. We had some really good returns come out, there were some really mixed returns throughout the classifications.
So we did see, and we’ll talk about this a little bit later, premium discounts. We saw discounts widen in equities. They narrowed a bit in fixed income. Again, we’ll talk about that. But yes, we did see some tax loss harvesting, I think it was more predominantly in December month-end. So they could better match those against those losses.
CEFA:
Many investors pay close attention to the way closed-end funds trade in relation to their net asset value. Did you see any specific trends in premium and discount behavior for December?
Tom Roseen:
We did. The median discount, as I was just saying, for the average closed-end fund … I’m using the word median discount in average closed-end fund, so I’m trying to take all the closed-end funds and say, “What was their median?” This helps us with removing some of the outliers at the top and bottom, those that had very high premium and very high discounts. But anyways, the median discount for the average closed-end fund widened 28 basis points to 11.97%.
Now, that’s wider than the 12-month moving average median discount of 10.81%. We are seeing numbers that are fairly high in comparison to where they’ve been. Saw a little reprieve here recently, from November actually. Some improvement from November, and also October. Where we finished was, at the equity, median discount for equity funds widened about 113 basis points to 13.16%. The fixed income discount was narrowed to about 26 basis points to 11.11%. So we did see some widening in equities, some narrowing in fixed income discounts.
CEFA:
How do current premiums and discounts compare to their historical averages?
Tom Roseen:
Well, I’m going to go back to January 31st, 2023. That’s 12 months, rather than going to the December figure. The reason is, remember what I was just saying, we have some tax lost harvesting, people have to wait for those wash sales to go away. Basically, we see a decline generally in the discounts, or a narrowing of discounts, by January. I’m going to give you those dates.
As of 1/31/2023, basically what we’re looking at is all equity funds had a discount, median discount of 8.35%. Now, remember I told you, the median discount currently is at 11.97% for all funds. Basically, if we take a look at where it peaked for this group, it peaked in October at 13.03%. We are seeing, again, a pretty big number increase from the beginning of the months. Or, the beginning of the year, in January, at 8.35%, to the peak at 13.03%, and we’re starting to edge down to 11.97%.
Now, how that equates though, on the equity side, if we take a look at it, we saw that the discount as of 1/31, so January 31st, 2023, was 8.62%. Now in December, it’s at 13.16%. For fixed income funds, it was at 8.18% in January, versus now at 11.11%. We have seen a widening of discounts over the year, as people became concerned with what we were talking about, interest rates going higher. We didn’t know if they were going to skip. And then, also just concerns with the equity market in September-October.
CEFA:
Which sector saw the greatest change?
Tom Roseen:
When we take a look at that, basically we saw taxable bonds, so this is a macro group not a classification, we saw they had the largest narrowing of its median discount, 103 basis points to 7.51%. And then, domestic equity macro group witnessed the largest widening of its discount, 78 basis points, to 11.91%.
CEFA:
Tom, since we last spoke in July, the Federal Reserve seems to be near the end of its rate hiking cycle. Inflation has slowed, but remains elevated. And economic growth has been resilient. We also have significant geopolitical tensions that have added to volatility, as well as Federal elections coming in November. How do you see the direction of the markets?
Tom Roseen:
Well, this is one of the areas that I think everybody would love to have that crystal ball. I think there is concern out there, that we’ve been hearing from Fed officials that they’re trying to be a little bit more hawkish in their views. In fact, yesterday, day before, day before that, we heard several Fed officials say, “Hey, listen, interest rates by the market sect did a lot of the needed work that we needed to stop the consumers from keep on purchasing and purchasing, and slow things down.” But they don’t think it’s enough yet to say we’re going to totally take any rate hikes off the bench. But in particular, they’re saying, “We don’t necessarily see cuts coming soon.“
The reason they’re pointing that out is, if you take a look at the Fed Watch tools, basically Fed fund future contracts that are being sold that indicate whether we are expecting a cut or not, over the next month, year, whatever the case may be. They were pricing in a 50 to 60 percent probability that we’d have a rate cut by March. Well, this is one of those areas that probably is not going to happen. They’re trying to put the brakes on. Most of them are still talking about having rate cuts sometime in 2024, but maybe not as soon as we expect.
When we’re taking a look at this, one of the things that we want to look at is what’s been out of favor. So utility funds and real estate funds, they were actually out of favor for the year. Utility funds won’t even return 1.5%. Real estate funds had a negative 0.59%. But both of these actually did pretty well in Q4. So we might be able to look at some momentum in those areas, and particularly if we believe interest rates will be cut.
On the fixed income side, we have general insured unleveraged funds, these are longer dated securities. If we expect interest rates to come down, the longer dated securities will have two things. They’ll have their relatively high interest rate, but also maybe some capital appreciation. For the year, general insured unleveraged funds were up about 6.80%. US mortgage funds were only up 6.2% for the year. I’m saying only, and I’m amazed I’m saying only after all this. In corporate debt triple-B rated funds were up to 7.15% for the year.
All these did fairly well in the quarter, so the momentum play and the idea, if we believe interest rate cuts are going to occur, we could have some benefit.
CEFA:
Are there sectors among closed-end funds where investors may find particular opportunities, given where those funds are trading relative to their historical averages?
Tom Roseen:
Again, I went through that piece a little bit. When we’re taking a look at the numbers, the particular areas that we’re interested in with, again, utility funds and real estate funds, and general insured funds, those are part of the story that we’ve been talking about. But one of the things that we want to focus on too, is some of the other areas that are not realized in, let’s say the broad based categories.
When we’re taking a look at some of the other pieces that we’ve looked at, science and technology actually did very well. Will they continue on? We’re not sure. That’s one of the areas that I’m a little bit vague on. Are we going to continue on with this run in science and technology? For instance, one of the best performing funds in the universe for December is ARK Venture Fund. ARK Venture Fund was up 26.18%. For the quarter, they were up 28.96%. And for the year, 61.23%.
Are there particular areas that you can play in and maybe get some good returns? I believe there are. But again, will we continue on with the momentum? Will we have a soft landing or a hard landing? And what are your expectations for interest rates going forward?
CEFA:
Tom, you also follow interval funds, which typically offer a limited quarterly liquidity to investors. How did interval funds generally perform over the second half of 2023?
Tom Roseen:
Interval funds had a little bit tougher road, to a whole. To be honest with you, they didn’t do as well as they have in the past. I think this is one thing that people have to take into account. When you’re working with interval funds, they really are more illiquid securities, maybe longer term bets. That’s why they’ve gone to become an interval fund. While they do want to offer redemptions, usually it’s only 5% of the assets on a quarterly basis. It’s because they don’t want to see a lot of cash sitting on the sideline, they want to put it in undervalued securities.
One way of saying, for the year, interval funds returned about 7.60%, while conventional closed-end funds returned 11.41%. With that said, we saw that high yield funds in the space for the year actually did very well, from an interval fund perspective, high yield funds returned 14.51%, while the conventional closed-end fund returned 9.28%.
If we take a look at the quarter, the disparity is a little bit wider. For the quarter, the average interval fund returned only 2.84%, while the average conventional closed-end fund had 9.27%. But now, I’m talking a little bit apples to oranges because interval funds are not in some of big focus areas. They’re usually in areas where they’re a little bit more niche focused. Again, the ARK Venture Fund is an interval fund that I just mentioned. That did spectacularly well, but other ones didn’t do all that well.
The best performer, if you will, as a group for the quarter was loan participation funds. They were up 2.77%, versus the conventional closed-end fund up 3.30%. There was still a little bit of disparity. But there was a bit of a lag, if you will, between interval funds and the conventional closed-ends funds. This quarter and this year.
CEFA:
What asset classes or investment strategies do you believe offer the most interesting opportunities for interval fund investors as we begin 2024?
Tom Roseen:
Again, I think the focus should be on, “Do I want to get into private equity or private fixed income?” What I mean by that is you’re going to expect a premia for having some illiquidity issues. It’s not something you’re going to look at quarterly returns, you’re going to look at one-year returns, and maybe even longer period returns. On the long haul, I would say private equity and private fixed income is the place.
Now, if we look at what’s really set up well for the interval funds is real estate classification has 40 interval funds, versus nine conventional closed-end funds. General bond, 40 and 24. Loan participation is 38 and 21. And global income, 23 and 13. The former number is the interval number, the latter number is the conventional closed-end fund. The reason I bring that up is it gives us more opportunity to evaluate particular interval closed-end funds against conventional closed-end funds to see what we want. The offerings, there’s more offerings in those spaces than any other classifications on the Lipper database.
CEFA:
Are you continuing to see expansion in the number of interval funds available for investors? And if so, what type of investments are these new products focused on?
Tom Roseen:
This is an amazing statistic. I’d have to ask others in the industry. I’ve looked around, I haven’t seen it yet. We had zero IPOs on the conventional closed-end fund side in 2023. While we saw 36 IPOs in interval funds. The mindset has come from some folks, either wanting to convert open-fund to an interval fund, because they don’t have to worry about redemptions, they don’t have to worry about the cash issues. They can go into less liquid securities. So we’re seeing that.
And where we saw the predominant creation, was we saw loan participation funds at about eight new interval funds. Global income, which I mentioned a little bit earlier, had about eight new interval funds added. And real estate saw five new interval funds added. We are seeing actually a proliferation of IPOs in interval fund space.
Also, when we take a look at mergers. Last year, we saw about 30 mergers or liquidations in the closed-end fund space. Only eight of those were interval funds. Really, the investment management community seems to be moving some of the newer issues, where they can come in with more private placement type of securities, and adding them via interval funds. It’s been an interesting year, 2023.
CEFA:
Tom, thank you so much for taking the time to join us today.
Tom Roseen:
Diane, thanks for having me. Happy New Year’s to everybody.
CEFA:
We want to thank you for tuning into another CEF Insights podcast.
This material is not, and is not intended as investment advice, an indication of trading intent or holdings, or the prediction of investment performance. All information is current as of the date of this presentation. Views and information expressed herein are subject to change at any time. LSEG Lipper disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources, however LSEG Lipper does not warrant its completeness or accuracy. This presentation is not intended to, and does not constitute an offer or solicitation to sell, or solicitation of an offer to buy any security, product, investment advice or service.
