Closed-end funds, primarily used by investors to capture income, have faced some dizzy spells since the Covid-19 market meltdown in March. The funds’ premium discounts (the difference between their net asset value and their share price in the secondary market) widened dramatically during the market selloff and then quickly tightened up closer to pre-crisis levels.
According to Closed-End Fund Advisors, a fee-based RIA in Richmond, Va., the average discount for the U.S.’s 498 closed-end funds hit 21.6% on March 18 and settled back at 8.6% in late April. Over the past 20 years, the average discount for closed-end funds has been 4.17%. The discount dipped beneath this March low just once, back in October 2008, when it hit 27.4%, says John Cole Scott, chief investment officer at Closed-End Fund Advisors.
Scott and other closed-end fund experts weren’t surprised by the March madness. These vehicles, like small-cap stocks, enjoy less liquidity and are therefore subject to bigger market swings. Although the discounts have shrunk and the rate of dividend growth is still likely to decline, the industry experts still see attractive opportunities for investors who have the patience to wait out the storm and not get emotionally sucked into the general market anxiety and Covid-19 uncertainties.
The recent market decline “was quicker and more violent than ’08-’09, but the funds were able to handle it better and they got in front of it faster,” says Scott, because closed-end fund managers had the experience of the great financial crisis and the energy pullback of 2015 and 2016.
This time, a number of these often highly leveraged vehicles unwound their debt before they were forced to by their banks. Scott likens this to “jumping out a window and breaking a leg but landing in the pool before getting burned up in the fire.”
Scott encourages financial advisors and investors looking for income opportunities to check out closed-end preferred equity and senior loan funds with good active management. These asset classes offer lower credit risk and are well suited for the closed-end fund structure, he notes.
Neither asset class is very liquid, but closed-end funds (unlike open-end funds) don’t have to hastily sell off assets to raise cash for investor redemptions. One fund Scott thinks investors would be happy with, the Flaherty & Crumrine Total Return Fund (FLC), invests at least half its assets in preferred securities issued by U.S. and non-U.S. companies.
Scott also highlights the Nuveen Real Asset Income and Growth Fund (JRI), which invests in real estate and other contractual assets, and Tekla Healthcare Investors (HQH). Both funds traded at double-digit discounts and yielded between 9% and 11% in late April.
Tekla Healthcare Investors, one of Scott’s longtime favorites, has become a very timely play with the focus on health care, pharmaceuticals and medical science, he says. Up to 10% of its assets are in private investments, which he notes aren’t easily found in ETFs or open-end funds because of those structures’ liquidity rules.
Municipal bond funds, which account for about one-third of the closed-end fund universe, are “a simple way to add yield for people who live in the high tax space,” says Scott. He likes the Nuveen Municipal Credit Income Fund (NZF).