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Buying Discounts: Closed-End Trio
02/10/2014 10:00 am EST
Greg Neer, director of research at Relative Value Partners, discusses his firm's specialized focus on buying closed-end funds trading at a discount. Here, he explains the strategy and highlights some favorite closed-end fund ideas for income and growth.
Steve Halpern: We're joined today by Greg Neer, Director of Research at Relative Value Partners. How're you doing, Greg?
Greg Neer: I'm well. Thank you for having me, Steven.
Steve Halpern: Could you tell our listeners a little about Relative Value Partners, and the background of the company?
Greg Neer: Sure. So, Relative Value Partners was founded in 2004 by Maury Fertig and Bob Huffman. The firm was founded on the premise of providing institutional level services to wealthy individuals and smaller institutions.
Bob and Maury brought their background of fixed income at Solomon Brothers to, kind of, a new market and initially started serving financial professionals and that has since grown to a wide range of high net worth individuals and smaller institutions.
Steve Halpern: Now, Relative Value Partners is known for specializing in the area of closed-end funds; before we go further, for listeners who may not be familiar with the closed-end fund market, could you briefly explain the difference between these funds and more traditional open-end funds?
Greg Neer: Sure; so, a closed-end fund is a registered investment company. Think of it just like an open-end fund, except, it has an IPO just like a normal stock does, and from the IPO on, it trades on an exchange.
So, one of the differences of closed-end funds versus open-end mutual funds is that closed-end funds trade at a premium or discount to their net asset value, which is determined by the supply and demand on the market.
So, if a lot of investors want a specific fund because of what it invests in, you can often see the fund trade at a large premium, and if investors are shunning a fund, or the assets it invests in, you can see it trade at a discount.
Additionally, closed-end funds have captive assets, so they don't have to worry about additions and redemptions from outside investors, and what's interesting is, there's really a closed-end fund for almost every asset class just like there would be for an ETF or a mutual fund.
But the unique thing is, you can buy a closed-end fund in any one of these areas, and often, if you're patient, you can buy them at a large discount to the asset.
Steve Halpern: So, a closed-end fund that's trading at a discount would generally suggest that that area is out of favor, whereas one that's trading at a premium would be an area that the market was more focused on at the current time?
Greg Neer: You know, sometimes it works that way and that's the simple answer, but, oftentimes, you'll see funds trade at discounts just because the market doesn't know about it; they don't know what they invest in, and it's not a widely told story, so, there can be many reasons why a fund can trade at a discount, but that is one of them.
Steve Halpern: Now, when you look at the overall universe for closed-end funds, are there particular areas you are seeing where there are large discounts or areas where the funds are currently trading at premiums?
Greg Neer: Sure, so, we're seeing a lot of value in taxable fixed income funds, and what we're seeing is, the average (or the median) of the taxable fixed income space is about an 8% discount, where, historically, it trades closer to a 4% discount, so it's trading at quite a discount to its average level.
Where we see the most value in this space is shorter duration funds that focus on a multitude of investment grade corporates, high yields, bank loans, and preferreds, and what we want to do is find funds that have a duration of, say, under five and a half years, maybe have some credit, but not too much, and they're trading at deep discounts, and also, have stability in their dividends.
There's also some value in the equity market funds. Where we see the most value in equity funds is the more defensive-oriented type of sectors, such as covered call funds.
One example of that is (BDJ), which we can talk about later, but funds that invest in stocks that have strong cash flows, big dividends, more stable type of sectors, and, sometimes, these funds will also self-call as a way to produce income while you're holding the stock.
Steve Halpern: Okay, so let's turn to some specific names; are there a few you would like to highlight for our listeners now?|pagebreak|
Greg Neer: Sure; so, for investment grade fixed income funds, I have two that I think make a lot of sense in this market: The first is (BTZ); the BlackRock Credit Allocation Income Trust.
BTZ is a fund that's been around for a while now, but it's changed its strategy and I think that's why investors have often overlooked this fund.
This fund is currently trading at about a 14% discount. It pays a yield of about 7.5% and it's earning its dividend, which is very important, because you can feel confident it'll maintain its dividend.
This fund invests in a combination of investment grade corporates, high-yield corporates, some bank loans, and preferred stock, and the duration on this is under five years. So, with all the fears about rising interest rates, a fund like this, with a duration less than five years, you can feel good about it, especially because it's at a 14% discount.
Steve Halpern: You mentioned there was a second fund?
It's about 63% investment grade corporates, and then it has some mortgage backs, some government, some developed market, and even a little bit of emerging market debt, but this fund has a managed distribution policy, which is interesting because, what it means is, the dividend will remain constant.
Currently, the dividend is about 9.16%, and because of the discount, which is about 7.4%, you're getting an extra 73 basis points of yield above the net assets.
In a tight fixed income market, obtaining an extra 73 basis points of yield is a difficult task, so, this is a fund that we feel confident in, for investors who want a short duration fund; it's got a duration of about 3.2 years, and with high quality assets.
Steve Halpern: Now, before we leave, is there anything in the closed-end equity area that you would suggest?
Greg Neer: Sure. One fund we really like in the equity space is BDJ. BDJ is the BlackRock Enhanced Equity Dividend Trust, so BDJ invests in companies that have attractive dividends, equities that we would consider fairly high quality.
The fund is currently trading at a 12.5% discount. It has a yield of about 7.4%, and because of the discount, you're getting almost a full percentage point in yield above what the yield is on the assets.
So, the same way that you buy a bond at a discount and the yield is higher, in closed-end funds, because of the near 13% discount, you're getting almost 100 basis points of free yield.
Steve Halpern: Well, thank you for joining us today; we really appreciate your insights in an area that a lot of investors aren't familiar with.
Greg Neer: Thank you for your time. Have a great day.
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