We contrarians like buying closed-end funds in October because their “discount windows” tend to open the widest this month, notes Brett Owens, chief investment strategist at Contrarian Income Report.
When mainstream investors get scared and sell, they flip anything that isn’t firmly attached to the floor. This includes CEFs, which see their price-to-NAV gaps expand when the market sells off.
The discount window is a phenomenon mostly confined to CEFs. They have fixed pools of shares, so their prices can wander above and below NAV based on how many buyers versus sellers — just like any stock. As value-focused contrarians, we of course prefer to purchase the funds when they trade at discounts.
ETFs, on the other hand, tend to create new shares as demand warrants. It’s possible, but extremely uncommon, to see them at discounts, and even then, the discounts are barely visible.
It’s a mystery why DoubleLine Income Solutions (DSL) — a top-notch bond closed-end funds that sports years of outperformance — offers a discount. Bond god Jeffrey Gundlach is at the head of DoubleLine.
Among the many reasons to invest with Gundlach is that he and his all-star team of fixed-income analysts buy bonds that you and I can’t, such as those issued by a Brazilian financial-services firm paying 7% and a petrochemical firm in Luxembourg yielding 8.8%. It’s worth paying a management fee for access to these deals.
If these ideas sound esoteric, well, they are, and that’s where the value is in Bondland. Without venturing around the globe, we’re stuck with high-yield US paper that pays a mere 3.4% or 3.8%. This is why we pay Gundlach and Co. the “big bucks” management fee. “Big bucks” is tongue-in-cheek because when we buy one of DoubleLine’s closed-end funds at a discount, we essentially get our fees “comped.”
We highlighted sister fund DoubleLine Opportunities Fund (DLY) earlier this year. DLY launched in early 2020 and its unfortunate timing actually ended up being a blessing because DLY was able to “buy the dips” in February and March 2020 while the world went into lockdown.
DLY was created to take advantage of income opportunities in mortgage-backed securities (MBSs), commercial MBSs and collateralized loan obligations (CLOs). The fund’s stormy start helped the team lock in higher credit quality than would otherwise be available with 7%+ yields.
Higher rates should not be a problem. The fund’s bond holdings have an average duration (time until they mature) of just over two years. This is impressively low and provides the fund with flexibility if interest rates were to rise more than we are currently expecting. (It won’t get caught holding unfavorable bonds for years; it can move its money around to take advantage of rate changes.)
Like DSL, DLY borrows money about as cheaply as possible. DoubleLine borrows at between 0.7% and 1.1% above LIBOR which, as DLY portfolio manager Jeffrey Sherman notes, is “pinned to the floor.”
DLY uses about 22% leverage, which is manageable and a nice kicker on its already high yields. The fund dishes a 7.2% dividend and trades at a 5% discount. And it’s run by the best bond team on the planet.
