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Contributor ○○

20 20 Vision

Random thoughts, observations, and rants on the CEF universe for this New Year

  • Richness - I'm amazed at how rich the CEF market is across taxables, munis, and even legacy/obsolete equity.  I don't see the mega trends of ETFization + cheap passive going away, and its going to get even cheaper to own narrower slices of markets.  We're probably only in the second inning of bond ETFization, and there's lots of room for yieldy sectors to get low cost passive competing analogs rolled out.  That will make a lot of middling FI CEFs get more competition, and if people don't need the leverage, those would be decent bond beta equivalents.  I've felt that CEFs are products that deserve to have warranted discounts to what cheap passive competitors offer.  Compare your favorite funds NAV returns to ANGL or VWOB to see how cheap/passive/unlevered competes.  In a world where expected returns on various bond sectors is maybe 4-5% paying 100 bps to managers really erodes the benefits of CEFs.  Maybe in some narrow cases the leverage is really worth something (like in an IRA that was fully invested and carrying no cash) but I don't think that reflects the typical investor.  Most people / organizations carry some cash .... typically not well thought out either.  
  • Cash - which segues into my next point!  I think investors of all kinds are better served really thinking through their cash needs, and stressed liabilities, than obsessing over the next new financial widget.  Assuming risky assets return more than safe ones, people should over the long haul earn more to meet their financial objectives and aspirations, if they keep their cash at optimal levels.  This means not just minimizing cash drag, but also reducing the risk of stressed asset sales because too little cash, or credit lines, were available when a stress event came up.  If one is invested in 'cash' because they respect the optionality value of it - its sort of like a bet on wide distribution of future prices - one should have a plan of how they plan to scale in/out of cash opportunistically.  And although I use the word cash, for most purposes that means MINT or NEAR to me, although I do keep checking/savings/CD's around too since those are even trustier forms of cash for immediate expenses.  I want to detail a cash stress situation I heard about last night (non professional situation) : elderly prosperous couple with children living all over the world.  one of their kids has their spouse die abruptly, while they are expatriate Americans living far away.  Their employer had been sending their teenage children to an English/American Intl School in that locality.  So the (adult) child relocates back to the family compound, along with the teen grandkids.  Because of everything that has happened (death of parent, mid year intl school change etc.) both kids need to be enrolled in expensive private local schools.  Grandparents suddenly have a 40k+ expense that needs to be funded for the next several years.  They have the resources for this, but not everyone would be liquid enough to address this.  Ultimately, people with resources are going to be on the hook for various extended family type of emergencies.  One can fight it, but most of these aren't cases of negligence or recklessness, and if one would have at the end, left money to that family member anyways in their estate plan, its better taking care of them now.  So bottom line: you may have more potential liabilities than you think, once you start to look more broadly at your network.
  • Anchor Shareholders - Generally I like the governance/alignment that comes from a big anchor shareholder, and look for that on my checklist.  But its a double edged sword and in some cases, that can end up working against the outside minority holders.  (CLNC is a good example of that at the moment, but that's a whole separate rant)  In the CEF world now, there are lots of funds that seem to have built up clusters of effective anchors guiding advisors towards better governance/terms.  When one sees 4-5 smart owners in the top ten holders, that's a good sign in CEF land nowadays.  Is it an iron clad protection?  Of course not, but its better than a situation with a small no value add advisor with a dispirited, disengaged shareholder base.  Small firms tend to fight much harder to keep their AUM since that CEF is likely to be material to the owners, while its a rounding error for big shops.  Additional implication: small funds/firms need a bigger warranted discount.
  • What I like - its been slim pickings for a year in CEF land.  Mostly I've been adding to names I'm already in.  My preference has been for discounts, overdistributing, and not horrendous NAV trends.  I dabbled a little in BDCs, mREITs when I thought a true sale (and thus a real valuation of the holdings) had happened.  Results have been mixed, so far.  I do like PCF, but its not as wildly cheap as it once was.  For aspirational money that doesn't have a fixed role yet in ones financial objectives, I'm ok with foreign stocks, especially big div payors.  In the absence of good governance signals, a div policy tends to focus mgmt attention and is a reasonable banner to rally on.  However, foreign & EM stocks have been cheap for years, and have been lagging.  So the investor who measures everything relatively may not see their charms.  But names like VYMI offer up a reasonable 4% yield now, and VNQI pumped out 7% on a trailing basis.  (I suspect the latter's go forward yield is more like 4%)  That's not awful given that they have some ability to grow the divs with inflation, and in a world where most safe foreign currencies yield nothing.  I don't really think CEFs are good for playing this theme, unless we had a real shakeout and the stocks and funds got way cheap.  For the avoidance of doubt though - on net I've been net selling CEFs for most of the last 10+ mos as they reached full valuation.  Some of the fills felt like crazy gifts at the time, but prices went higher in few cases.
  • Muni land - separate side note.  I don't pay enough attention to the space, but SCOTUS has refused to hear the pleas of the bond insurers in a Special Revenue bond dispute.  Basically, some of the protections that investors think was supposed to protect them when they lend to special projects (highway bonds, school construction etc.) may not be as strong as they hope.  I've long felt muni credit is much more fractionated than conventionally understood, and likely to really blow up in certain areas in the next 5-10 years.  But I've felt that way a long time, and nothing has happened, and at least I didn't get all the agita that Meredith Whitney got for feeling (and saying) the same.  My more practical advice would be: for those who have the ability, just get away from those poisoned chalice states.  Long before the bonds formally default, they will default on all the essential services that citizenry expect from their tax dollars.  Most of you who live in those places know if you have that risk ....but it's getting worse.
  • And lastly, professionally it seems like I'll be shifting to a new role some time in the near future.  
12 Replies
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Participant ○○○

Re: 20 20 Vision

Thank you for this write up, Aub.  I tried to bring attention to investors' assessments of their liquidity needs and goals due to the historically pricey asset values in a December MeltUp post on Fidelity forum, and had my head handed to me :).  CEFs are just another wrapper that reflects the current state of the world where the struggle for income is real.  I have reduced my personal CEF holdings significantly last months -- especially those traded at premia.  

Wishing you the best with whatever next career step you're taking, even if it is a break.  Would love to grab coffee/ lunch one day in NYC if /when you are there.  JR

 

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Re: 20 20 Vision

What's crazy is clients/organizations who are taking risk that they don't have to.

I saw the story the other day of some person who had an 18 year old daughter, with 529 + Coverdell accounts that could full pay for their upcoming college tuitition, who has an allocation of 100% US stocks + AAPL.  Over their years of saving, they've hit a 4 bagger with that combination (presumably the AAPL was in a Coverdell as I didn't think 529's generally allowed single stocks) and now they are reluctant to get off that horse since its made them so much money.  Little Big crazy to me, since educational savings accounts are poor places to gamble since losses are not deductible, and for the most part, surplus capital can't be efficiently repatriated/reallocated given taxes/drag, no step up in basis upon death etc.

=======

I haven't gotten to NYC in recent years but when I am next there I will post a shout out.  Mrs. Aubergine just got back from there with all her horror stories of Newark Airport so it'll take some time for der furcht to subside ....

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Frequent Contributor

Re: 20 20 Vision

"investors' assessments of their liquidity needs and goals"

Also their income needs, as well as their assessment of the risks associated with that income!

"CEFs are just another wrapper that reflects the current state of the world where the struggle for income is real."

I choose to double wrap my CEF allocation by using the UBS 2X leveraged ETNs, CEFL (new CEFZ)!  Six ways I view things.

  • At the well known and understood risk of holding unsecured UBS debt, rather than actual assets (individual CEFs), I get, roughly, twice the income for a given investment amount.
  • At that same risk, I minimize the risk of holding a few individual CEFs by 'holding' a basket of 30 of 'em.
  • If I struggle for income at 1X leverage, there's usually no problems at 2X!
  • Whether markets rise, fall, or are flat, the steady income produced by CEFL, which more than covers my retirement withdrawal needs, makes me agnostic to unit price behavior.
  • Nevertheless, falling unit prices allow me to pick of some lower priced units with excess income not withdrawn and spent
  • Finally, the time to be in leverged products is whenever markets are on the rise, even a MeltUp, as they usually are over longer periods of time
  • (A 7th. way is that, ifn I had significant assets in a regular taxable account, I could hold CEFL and use margin, which isn't available to me in my tax deferred accounts.  SO, 2X would end up 4X.  The cash carry on borrowing money at, say, 8% to earn 17% would seem to be a no brainer!)  8-)

 

 

ElLobo, de la casa de la toro caca grande
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Re: 20 20 Vision


@aubergine wrote:

What's crazy is clients/organizations who are taking risk that they don't have to.

I saw the story the other day of some person who had an 18 year old daughter, with 529 + Coverdell accounts that could full pay for their upcoming college tuitition, who has an allocation of 100% US stocks + AAPL.  Over their years of saving, they've hit a 4 bagger with that combination (presumably the AAPL was in a Coverdell as I didn't think 529's generally allowed single stocks) and now they are reluctant to get off that horse since its made them so much money.  Little Big crazy to me, since educational savings accounts are poor places to gamble since losses are not deductible, and for the most part, surplus capital can't be efficiently repatriated/reallocated given taxes/drag, no step up in basis upon death etc.

=======

I haven't gotten to NYC in recent years but when I am next there I will post a shout out.  Mrs. Aubergine just got back from there with all her horror stories of Newark Airport so it'll take some time for der furcht to subside ....


Newark is paradise compared to La Guardia which has been turned into a Demolition derby of delays and long walks due to extensive construction to modernize the an 80 year old Airport where there is no room to expand the facilities  because it is built at the edge of a stagnant bay.

 

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Re: 20 20 Vision

 

Thanks for post, Aub.

R48

 

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Explorer ○○

Re: 20 20 Vision

Appreciate your thoughts Aub.  Agree fundamental value proposition of CEFs has eroded, both pricing and the continuing trend of ETF competition.  Counterweights to that -- yield seeking, potential for return to zero rates and desirability of leverage,  high valuations generally in US markets "justifying" high valuations in CEF land.    I'd suggest derisking from CEFs to ETFs is not special to CEFs but similar to the concept derisking generally in bubbly market.

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Re: 20 20 Vision


@jon1212 wrote:

Appreciate your thoughts Aub.  Agree fundamental value proposition of CEFs has eroded, both pricing and the continuing trend of ETF competition.  Counterweights to that -- yield seeking, potential for return to zero rates and desirability of leverage,  high valuations generally in US markets "justifying" high valuations in CEF land.    I'd suggest derisking from CEFs to ETFs is not special to CEFs but similar to the concept derisking generally in bubbly market.


I, too, appreciate these comments.  Main difference between CEFs and ETFs is discount/premium, which arbitrage takes away for ETFs.

 

ElLobo, de la casa de la toro caca grande
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Explorer ○○

Re: 20 20 Vision

Any thoughts on CEFs today vs the feel in 2012? 

I only started trading CEFs seriously in late 2013 so don't have the visceral experience of 2012, but the exuberance in CEF land looks like it was out of control at the time.   

(I did briefly toy with CEFs in 2008, now that was visceral)

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Re: 20 20 Vision


@jon1212 wrote:

Any thoughts on CEFs today vs the feel in 2012? 

I only started trading CEFs seriously in late 2013 so don't have the visceral experience of 2012, but the exuberance in CEF land looks like it was out of control at the time.   

(I did briefly toy with CEFs in 2008, now that was visceral)


Things were really frothy in 2012, and I too was all bulled up.  

I wrote a note on a single name that year, invested, and although everything has come true, and returns have been more than adequate, it just took longer than I ever expected to pan out.

But yields were a bit higher back then too, so some of the general tightness today comes from the overall compression in that.

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Re: 20 20 Vision


@JRinNY wrote:

I tried to bring attention to investors' assessments of their liquidity needs and goals due to the historically pricey asset values in a December MeltUp post on Fidelity forum, and had my head handed to me :). 

 


I for one appreciated that post from you, as I do this one from Aub.  I've been holding onto my high-prem CEFs (the typical  PIMCO stalwarts) but am not ignorant of the risks you both have mentioned. 

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Re: 20 20 Vision

The other thing I forgot to append to my original post:

For taxable investors who might be considering muni bonds: take a look at some of the overdistributing taxable funds, especially the BlackRock suite.  They seem to be very consciously pumping out way too much distributions (vis a vis their earnings) due to activist pressure.  So that can make their end tax characterization super interesting i.e. lots of Return of Capital which isn't taxed.  Now its true that usually means declining/decaying NAV but these may have less duration than conventional muni funds.  I was just looking at some of the recent numbers where they fractionate between NII, CGs, ROC for 2019.  BHK, BIT, BTZ are all at least 25% ROC for last year, with BIT clocking in at 37%.  (NAV TR is TERRIBLE for that last one, so one has to really have a think through on whether their private loans will ever recover).  The first January allocations are even higher with ROC's coming in at a min of 58% for all three.  Now the caveats are many: the first is that these SEC disclosures may end up being nothing like what tax forms look like, and there is no requirement that they have any consistency nor synchronicity.  And of course, these aren't super stable numbers, so the numbers at the end of the year can change depending on the market and what port mgmt does.  So if one is managing their AGI for a super precise number (like Obamacare subsidies or something) and going a few bucks over a hard dollar number has disastrous consequences....one should not be dabbling in this whole concept.  And lastly ROC is only really useful to the extent these funds are discounted, and NOT busy blowing themselves up.  Final Tax characterization of prior year distributions is often a data point one has to get from the sponsors web site, or a broker.  It doesn't seem to be typically included in Annual/Semi Annuals.  I think its a relevant data point for investors, but the lawyers who review all these kinds of docs before they get filed tend to have a bias for removing info that is not mandated.  

So with all that info here's how I would estimate an after tax yield for BIT if I believed in those numbers going forward

9% yield.  Pretend 40% will be tax free ROC and 60% at an all in rate of 50% assuming you're well off and living in a high tax burden jursisdiction.  (9% x .40) + (9% x .60 x .50) = 6.30% 

That seems superficially more intriguing than (hypothetically) MMD and a 4.75% after tax yield.  For those who are the cusps of other income tax thresholds (NII, IRMA etc.) then this may not work either.  

I started thinking about this all over again because a REIT I keep an eye on has declared a pretty huge portion of their 2019 payout to be ROC, and I was somewhat surprised by the magnitude.  

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Re: 20 20 Vision


Hi JR (also Aub), Thanks so much for your (JR) referenced post. As a result I de-risked a bit and purchased some EDV as a hedge (not enough, alas). I'd suggest that instead of having your head handed to you it was one or two posters pulling your hair out one by one with their multiple posts. ;) I consider you to be one of the few voices of reason here not driven by ego but more community service. Thanks for that. I hope it does not dissuade you from further comments you deem appropriate. I wish you the absolute best in 2020. Your clients are lucky to have you, I think. RM

@JRinNY wrote:

Thank you for this write up, Aub.  I tried to bring attention to investors' assessments of their liquidity needs and goals due to the historically pricey asset values in a December MeltUp post on Fidelity forum, and had my head handed to me :)..  JR

 


 

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