CEF Weekly Review: Tracking Fund-Of-CEFs Holdings

Welcome to another installment of our CEF Market Weekly Review, where we discuss closed-end fund (“CEF”) market activity from both the bottom-up – highlighting individual fund news and events – as well as the top-down – providing an overview of the broader market. We also try to provide some historical context as well as the relevant themes that look to be driving markets or that investors ought to be mindful of.

This update covers the period through the third week of April. Be sure to check out our other weekly updates covering the business development company (“BDC”) as well as the preferreds/baby bond markets for perspectives across the broader income space.

Market Action

Most sectors finished lower on the week with only MLPs and Utilities registering NAV gains. Month-to-date, all sectors are in the red – Loans have held up the best.

April returns have shaved off a bit more than the gains over March, however CEFs still retain a healthy gain year-to-date.

Municipal CEF discounts remain wide both in absolute terms (y-axis) as well as relative to their own history (x-axis). Loan CEF discounts have tightened sharply and look somewhat expensive.

Market Themes

The holdings of two actively-managed funds of CEFs – CEFS and FCEF are back in the CEF Tool. The reason we like to track CEF holdings of these funds is that it gives a window into what institutional investors are holding. In our view, the holdings of these funds is different from the “institutional investor” ownership percentages investors see elsewhere which are much less interesting since they often reflect direct retail ownership via accounts held in private banks of large banks and managers.

CEFS is an ETF managed by CEF activist Saba while FCEF is an ETF managed by First Trust. Historically, FCEF has had an Equity flavor (its Equity allocation is around ⅔ of the portfolio) while Saba has had a credit flavor. Saba’s focus has shifted recently towards Equity funds, particularly the BlackRock Equity CEFs which continue to trade at wide discounts.

5Y CEFS total NAV returns are around double that of FCEF at 11% vs 5.5%. Saba’s returns have no doubt benefited from its activism and more conviction (i.e. lower diversification – top 3 allocations are 36% of the portfolio). Between the two, we give CEFS more weight. Their holdings are always worth a look and can be a good play tactically both to piggyback on the activism as well as smart discount plays. Top 5 CEFS holdings are ECAT, BIGZ, EMO, ADX, ASA.

Market Commentary

Two DWS Municipal CEFs KSM and KTF are terminating with the dates set in 2024 and 2026 respectively. Interestingly, only KTF has sharply boosted its distribution although it’s not at all obvious why it would want to or need to. The discounts of both funds look too wide for funds that have announced a termination. Although both look attractive, we favor KSM here at a 4.5% discount into its proposed termination later this year.

The loan CEFs AIF/AFT hiked the distributions once again. It’s as though the CEF managers don’t want their shareholders to vote for the MFIC merger. After all, if your fund keeps hiking, it’s not obvious why you’d want to get rid of it. All in all, there is no reason for the CEF shareholders to vote for the merger. If they want to hold MFIC they can go out and buy some shares directly.

The Flaherty suite of preferred CEFs hiked their distributions once again. This is the second time the funds have hiked recently. The funds have not yet benefited from an increase in net income due to lower leverage costs but they are clearly positioning for an eventual drop in leverage costs once the Fed begins to hike rates. Preferred CEFs have an attractive profile of relatively high-quality securities with medium duration in the current environment of tight credit spreads and elevated longer-term rates. This is the second hike for PFO since it went into the Core Income Portfolio.

The SABA CEF (SABA) was added to the Hybrid sector of the CEF Tool. Recall that the fund is managed by the CEF Activist Saba which took over the Templeton fund GIM. Overall, this outcome can be viewed somewhat cynically (and perhaps correctly) in that much of Saba’s activism has less to do with doing right by shareholders (by putting pressure on underperforming managers) than trying to take over funds to generate management fees.

In this case, however, it’s hard to feel bad about Templeton whose fund managed to generate a negative total NAV return since inception. It’s likely SABA is going to do much better. The long-term returns listed on the SABA fund page are clearly irrelevant as they apply to GIM.

The sister fund BRW is the other CEF managed by the company. SABA has a lower management fee than BRW of around 0.65% vs. 1.05% – a significant difference. In terms of allocation, BRW has a larger CEF footprint with 37% of the portfolio vs. 12% for SABA though the latter number will likely grow. SABA trades at a wider discount than BRW however this should change over the medium term.