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 last week of August. 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
CEFs recovered from their early-August drawdown and then some. All CEF sectors finished August in the green, with the higher-beta MLP and REIT funds leading the way.
August finished on par with the previous three months. There has only been one down month since October of last year.
From a total return perspective, CEFs have now recovered their post-2022 drawdown.
Fixed-income CEF sector discounts have continued to tighten, while equity CEF sector discounts have lagged. Fixed-income CEF sectors are now firmly in expensive territory.
Once we take into account both credit CEF discounts and underlying credit spreads, we can see that we are getting very close to the late-2021 level of overvaluation. Overall, this picture does suggest that credit CEFs, in aggregate, do not present an attractive value proposition. That said, there are key differences between today and late 2021 – namely that leverage costs will be falling rather than rising and interest rates are still relatively high.
Market Themes
AllianceBernstein Muni CEF AFB hiked the distribution by 10%. Recall that Muni CEFs have been hiking distributions left and right, particularly those managed by Nuveen, Eaton Vance, BlackRock, Invesco, and Western Asset. However, not all managers have participated, with AB and BNY Mellon notably absent. This has resulted in a wide disparity in distribution levels.
Interestingly, the distribution differences do not say anything about discounts, despite managers’ hopes that hikes would tighten discounts. If we look at the relationship between distributions and discounts for unleveraged Muni CEFs, the R^2 is 1% in the “right” direction (i.e., higher distributions are associated with tighter discounts) which statistically implies no relationship. Year-to-date, the Muni CEF sector discount compression has outperformed that of the average sector. Perhaps the hikes helped the overall sector, but not the specific funds that hiked.
Market Commentary
Recall that Bill Ackman couldn’t convince enough people to buy into his CEF PSUS IPO as most people, correctly, expected the fund to trade at a discount afterwards. This creates a bootstrapping problem for the fund, as no one wants to be the one to sacrifice their capital, buying shares at the NAV so secondary-market investors can buy the fund at a discount. The easiest way to break through the logjam is for Ackman to put in some money for free. Economically, it could still be a win, as he will recover the money over time through fees. Another option is to put warrants or shares of the management company Pershing Square into the pot. That could be compelling enough for everyone to bring the IPO back to life.
BlackRock discount program tender offers flew by last week. The pro-ration numbers ranged from 6% for MVF to as high as 27% for BME. At the high end, this delivered annualized alpha of 6%. Also recall that the Eaton Vance Muni fund EIM had a tender offer in July, and that one had an amazing pro-ration factor of 47%. At this point of the two Muni funds, EIM is more attractive than MVF, even if it has a lower number of tender offers per year. These conditional tender offer programs allow investors to generate an attractive amount of alpha in an environment of fairly unattractive beta.
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