Weekly CEF Commentary | January 12, 2019 No ratings yet.

(This report was published to members of Yield Hunting on Jan. 12. All data herein is from that date. This is a rare posting of our weekly commentary with a two-week lag).

Macro Picture

The conflict in the Middle East appears to be subsiding, allowing the volatility index to retreat back into “risk-on” territory. In fact, it never really got out of it even during the peak of the ‘ran war fears. The Dow Jones Average surpassed the 29,000 mark for the first time ever. Given these large numbers, the index doesn’t have to rise much to keep making new milestones. In fact, the Dow only has to rise 3.4% to hit 30,000.

All benchmarks hit records this week with the Nasdaq up the most as technology shares outperformed. Small caps remain extremely cheap relative to large caps. The bond market had another solid week with all areas rising in value. The AGG rose by 30 bps on the week as interest rates fell modestly.

The big data point came out on Friday with the December jobs report. The labor dept noted that 145K new jobs were created which was a bit underwhelming compared to expectations. The underlying details of the report also were a bit weaker including more muted wage gains than we had been seeing. This did have the effect to push down long-term bond yields as investors bet the Fed would be on hold for longer. From a larger perspective, this was the 10th year in a row of payroll gains – the longest streak in 80 years.

Upcoming next week is the official signing ceremony for the Phase One trade deal with China. That could bring some additional optimism. Still, interest rates remain stuck in their tight channel in the 1.80s to low 1.90s and its hard to see what will drive them above that. With oil backing down below $60 as the Middle East cools, the main catalyst for higher rates seems to be fading for now.

It could be that euphoria enters the stock market and that causes a significant rotation out of bonds and into stocks. However, this seems unlikely on a larger scale as so many boomers are retiring and investors nearing retirement take risk off the table. It’s my thinking that equity fund flows could have a hard time sustaining a strong positive trend and that bond flows will continue to exceed them.

Data by YCharts

Equity markets look really stretched on short term. The S&P already is up 1.2% in January and most technicals look very overvalued. Earnings season is going to heat up in the next couple of weeks and is likely to be the driver of the markets for the coming months.

Closed-End Fund Analysis

Distribution Increase

Lazard Global Total Return (LGI): Distribution increased by 19.9% to $0.10646 from $0.08879

Eagle Growth and Income Opp (EGIF): Distribution increased by 6.25% to $0.085 from $0.08.

Distribution Decrease

Highland Global Allocation (HGLB): Distribution decreased by 20.75% from $0.084 from $0.106.

Apollo Senior Floating Rate (AFT): Distribution decreased by 4% to $0.096 from $0.10.

RiverNorth DoubleLine Strategic Opp (OPP): Distribution decreased by 1.8% to $0.18 from $0.01833.

Activist Trading

  • Saba continues to buy shares of Voya Prime Rate (PPR), adding another 350K shares or 1.4%. They now own 17.5% of all shares.
  • Saba continues to unload shares of Western High Income II (HIX) where they sold 296K shares or another 3.1% of their shares. They still own 10.9% of shares.

Rights Offering

Cohen and Steers Quality Income Realty (RQI): The fund announced a transferable rights offering for those that own the fund on January 17th.

    • Certain key terms of the Offer include:
      • Holders of Common Stock on the Record Date (“Record Date Stockholders”) will receive one Right for each outstanding share of Common Stock owned on the Record Date. The Rights entitle the holders to purchase one new share of Common Stock for every 3 Rights held (1-for-3); however, any Record Date Stockholder who owns fewer than three shares of Common Stock as of the Record Date will be entitled to subscribe for one share of Common Stock. Fractional shares of Common Stock will not be issued upon the exercise of Rights; accordingly, Rights may be exercised only in ratios of 1 new share of Common Stock for every 3 Rights, except that any Record Date Stockholder who owns fewer than 3 Rights as of the Record Date may subscribe, at the Subscription Price (defined below), for one full share of Common Stock.
      • The subscription price per share of Common Stock (the “Subscription Price”) will be determined on the expiration date of the Offer, which is currently expected to be February 13, 2020, unless extended by the Company (the “Expiration Date”), and will be equal to 95% of the average of the last reported sales price of a share of Common Stock of the Company on the New York Stock Exchange (the “NYSE”) on the Expiration Date and each of the four (4) immediately preceding trading days (the “Formula Price”). If, however, the Formula Price is less than 90.25% of the Company’s NAV per share of Common Stock at the close of trading on the NYSE on the Expiration Date, the Subscription Price will be 90.25% of the Company’s NAV per share of Common Stock at the close of trading on the NYSE on that day. The Subscription Price will be determined by the Company on the Expiration Date.

Weekly Commentary

Discounts for CEFs hit a new tightness factor closing to an average of just -3.45% last week, from -3.70% the week before. Clearly the January Effect is taking hold. The biggest driver of that discount level has been equities which had been fairly stagnant watching their fixed-income CEF brethren do all the discount closing. Equity CEFs now trade at an average discount of -5.10%.

Across sectors, the best performers on the week were mostly equity funds with real estate, emerging market equity, dividend equity, and utility categories all doing well. The sole bond sector to make the list was Senior Loan, which continues to rebound strongly.

In the Core funds, the best section if you look at in the Statistics segment below is the premium and discount change. This shows the top 5 “Core” funds that made the largest move relative to NAV on the week, both up and down. For example, the Western Asset Invest Grade Income (PAI) increased its premium by 3.53% on the week. A significant move. So the left side are those funds that became more expensive and the right side those that became cheaper.

But just because the fund is on the right doesn’t automatically make it a “buy.” For instance, JH Investors (JHI), a fund I own a decent amount of, backed off by 1.4% in excess of the NAV. You can see that below from the screenshot from CEFConnect:

But the discount is still tighter than the one-year average and still not overly compelling. If you look on the Model Sheets, row 49, you see that the rating is a “hold” and the “buy under” price is -9%. We have some ways to go before we get there.

Apollo Tactical Income (AIF), a Core holding for some time, has finally made its move. We’ve been patient on this one as it seemed to not want to be permanently stuck at a wide double-digit discount. It’s now moving up and not only is the NAV rising nicely, but the price is rising faster, closing some of the discount.

Overall, no actionable data on the Core stats section.

The All CEFs section has some valuable insight. Again, the most valuable section:

First, Eagle Point Credit Company (ECC) saw its premium increase over 12% on the week. That’s because the price went up and the NAV was adjusted down, again. This fund is a disaster waiting to happen. The yield is compelling at over 15% but you are picking up pennies in front of a steamroller with casts on your legs.

On the discount side, you have several of the PIMCO muni funds that recently chopped their distribution significantly. We are doing a review of these funds currently. RQI also is on the list because of the new rights offering. More below on that.

Highland Global Cuts Distribution

Highland Global Allocation (HGLB) recently announced the cutting of their distribution by more than 20%. This fund is relatively new as a CEF after being converted from an open-end mutual fund to cap cash flows after the lawsuit win. The cut was surprising given that the fund has not earned the distribution since it was created. But if they are willing to cut on HGLB, I’m more hesitant to own NHF at this point. NHF hasn’t earned their distribution in a long time and their last cut is now more than three years in the past. We just issued a sell alert on NHF in the Flex Portfolio.

RQI Rights Offering

On the rights offering for Cohen & Steers Total Realty Income (RQI), we think the dilution will be fairly minimal. If you own shares of RQI like I do, you have a choice to subscribe or not. For every three rights you have you will be able to purchase one share of stock. My standard thought is to sell out of a position once a rights offering is announced. And as I noted on the chat that morning, I was looking to sell. But then I didn’t getting side tracked by other stuff. The shares went from being down 61 bps to over 250 bps in about 90 minutes. At that point I deemed it too late to sell. I’m going to subscribe to the rights offering now as it gives us the ability to purchase new shares at 95% of average last sale price.

Buy/Sell Options

I know there isn’t much to buy as it seems like everything is at least fairly valued if not significantly overvalued. Here are some options:

  1. Lazard Worldwide Dividend & Income (LGI): This fund recently increased the distribution by 20%. Again, this is meaningless in the grand scheme of things since they are just returning your own money back. However, it does garner more investor interest which tends to close the discount. It’s the only “buy” rated fund on the Flex Portfolio right now.
  2. Western Asset High Income II (HIX): This one is highly liquid and Saba is selling about 100K shares per day. This is one of the few funds trading at a discount wider than average. It’s a non-investment grade bond fund so its not something recession resistant. Given the higher absolute yield and wider discount, it’s likely to attract more investors.
  3. Invesco PA Value Muni (VPV): The only muni CEF now in buy territory. The fund was a hard sell not long ago in the taxable income portfolio, but shortly after we sold it the discount widened dramatically. The yield is compelling at 4.37% tax free.
  4. Invesco High Income II (VLT): Another non-investment grade bond fund similar to HIX and HIO. The yield is strong at 8% and the discount is nicely wider than the average over the last year.
  5. Nuveen Diversified Div & Income (JDD): This is a managed distribution balanced fund with 50% stocks and 50% bonds. The bonds are a mixture of investment grade and non-investment grade. The stocks are mostly REITs like apartment and storage REITs.

Sell Candidates

  1. Eaton Vance Senior Floating Rate (EFR): The shares have taken off lately and the price closed the gap with the NAV by over 4 points in the last month and a half.
  2. Nuveen Senior Income (NSL): This is one I own a bit of and will likely unload fairly soon (hopefully capturing another point or so). The discount is now at -8% from -10.8% a month ago and -12% two months ago. Still, the fund is not back to its three-year average discount of -7.4%. That figure is greatly influenced by when it reached a premium for most of 2017. That is why I’m waiting a bit longer to unload it. Plus the January effect.

There are other funds that are getting into the frothier territory. We will keep you posted on them.

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Disclosure: I am/we are long LGI, VLT, HIX, VPV, JHI, AFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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