The diverse universe of closed-end funds offers exposure to actively managed investment portfolios that typically feature more dynamic strategies compared to passive ETFs. While investors are often attracted to the income focus of the various funds with impressive yields and managed distributions, the total return potential can also be significant with a corresponding level of risk. This article highlights the performance of CEFs year-to-date while analyzing trends across asset classes and sectors along with our view on where the market is headed next.
CEFs Performance YTD 2020
In a year defined by the global coronavirus pandemic and extreme financial market volatility, CEFs as a group have delivered a wide range of returns. The data we’re looking at with a coverage universe of 436 CEFs shows the average fund is down by 7.4% year to date, representing an underperformance to the broader equity market as the S&P 500 is up 8% over the period. Returns among CEFs are skewed given a concentration of leveraged funds in high-yield strategies with particular exposure to the energy sector which has weighed down the overall performance.
(source: data by YCharts/chart by BOOX Research)
CEF Themes This Year
Compared to the period of deep pessimism and risk aversion during the early stages of the pandemic in Q1, aggressive fiscal stimulus and accommodative monetary policy have supported more bullish momentum more recently. Fixed income and bond funds have delivered strong returns this year on a relative basis driven by the lower rates. The challenge for CEF investors is that many funds target high-yield and non-investment grade opportunities that have underperformed given wider credit spreads.
Stocks have rallied significantly off the lows from March, leading to an overall positive year for equity funds. CEFs with targeted exposure to growth-factor companies and sectors like technology or healthcare have performed well. On the other end, energy has been a laggard given the weaker pricing environment, leading to distribution cuts in most energy funds and poor performance. The following points summarize some of the themes in CEFs this year.
- Extreme market volatility since the emergence of the pandemic sell-off has driven a wide divergence of returns among CEFs in various asset classes.
- Energy sector-focused funds across equities and credit have underperformed with the group particularly impacted by the lower pricing environment.
- Stand-out winners this year include precious metals fund supported by a strong bull market in gold and silver.
- High-yield and junk-bond fixed income have been pressured from wider credit spreads despite lower interest rates.
- Municipals have been generally resilient with lower volatility representing a defensive group among CEFs.
- Distributions cut a common theme among funds with declining NAVs.
- Widening discounts in terms of the share price to NAV spread have further pressured shareholder returns.
The Top-Performing CEFs YTD
(source: data by YCharts/table by BOOX Research)
The table above highlights the top-50 best performing CEFs year to date in 2020. Data for year-to-date return on the net asset value, the current NAV to share price spread, and distribution yield is also presented.
As mentioned, CEFs investing in precious metals or with exposure to sector miners have been a stand out this year. Indeed, the ASA Gold and Precious Metals Fund (ASA) with $473 million in total assets is the top-performing CEF in 2020, up an impressive 55.7%. ASA is unique among closed-end funds as the only example which invests exclusively in precious metal mining stocks. We covered the fund with an article back in December of 2019, highlighting an impressive track record of outperforming sector benchmarks.
ASA remains one of our top picks to take advantage of what continues to be positive fundamentals for gold and silver. The combination of tight mining supplies along with investor demand in a safe-haven asset support the near-term outlook. For context here, the price of gold reached an all-time record high in early August at $2,090 per ounce and is up 27% this year. Among the top-10 CEFs this year, the Sprott Physical Silver Trust (PSLV), Sprott Physical Gold and Silver Trust (CEF), and Sprott Physical Gold Trust (PHYS) are on the list and invest directly in bullion representing direct exposure to the commodity price.
Equity CEFs that have outperformed this year are invested in technology and healthcare. The underlying companies proved to be resilient to the economic disruptions caused by the pandemic and in some cases even benefited from a surge of demand. For technology, themes like cloud-computing, remote working, virtual learning, and the popularity of gaming have driven sector momentum.
The BlackRock Science and Technology Trust (BST) along with its similar “sister-fund”, the BlackRock Science & Technology Trust II (BSTZ) are each up by about 41.5% this year benefiting allocations in big winners. The AllianzGI Artificial Intelligence and Technology Opportunities Fund (AIO), up 22% this year, is another example of a top-performing tech-focused equity fund. More diversified equity funds with a growth tilt and exposure to tech stocks have also performed well considering the Liberty All-Star Growth Fund (ASG) is up 23% year to date.
In healthcare, companies involved in developing treatments for COVID-19 or seeing increased demand for products related to the global public health crisis has supported strong returns in the group. Again, another BlackRock fund, the BlackRock Health Sciences Trust II (BMEZ), is up 28% year to date and is benefitting from the market dynamics. The Tekla World Healthcare Fund (THW) and Tekla Life Sciences Investors Fund (HQL) are each up 13.4% year to date and also strong performers.
On a relative basis, it’s also worth pointing out overall strong returns for fixed income and bond funds this year. Bond funds benefiting from the environment of declining interest rates and quantitative easing from the Fed have delivered for investors. In particular, convertible bonds have been well-positioned in the current environment with strong returns. The Calamos Dynamic Convertible and Income Fund (CCD), the AllianzGI Diversified Income and Convertible Fund (ACV) are each up 24% and 19% this year, respectively.
The Worst-Performing CEFs YTD
Turning our attention to the laggards, some of the losses suffered this year among the worst-performing CEFs have been devastating. In particular, the worst-performing funds are centered around a group that invests in midstream energy master limited partnerships (“MLPs”). Considering the collapse in energy prices this year combined with the leverage used by the underlying MLPs and additional portfolio leverage by the funds, the results have been disastrous.
(source: data by YCharts/table by BOOX Research)
Examples like the Duff & Phelps Select Energy MLP Fund (DSE), Cushing MLP & Infrastructure Total Return (SRV), Center Coast Brookfield MLP & Energy Infrastructure Fund (CEN), Tortoise MLP Fund (NTG), and the Goldman Sachs MLP and Energy Renaissance Fund (GER), which are each down by more than 80% this year, highlight the risks of a leveraged strategy.
In most cases, the extreme drop in asset values has forced a cut to the fund’s distribution rates. The yield figures listed above are based on the forward yield annualized from the most recent payouts although further cuts may be possible. The other dynamic to highlight is the wide discount to NAV among the worst-performing funds in part reflecting investors aversion to these strategies given the poor returns.
Our take here is that while some of these funds could ultimately dissolve, a case can be made that the laggards here could represent good opportunities in a scenario where energy prices recover. One fund we like in particular is the BlackRock Energy & Resources Fund (BGR) with $211 million in total assets and currently yielding 9%. In contrast to most of its CEF peers, BGR does not invest in MLPs and instead focuses on global energy producers that include mega-cap sector leaders. We covered BGR with an article back in April, and while returns have been relatively flat in the period since, we remain bullish on the fund.
With a stabilizing macro outlook and a clearer indication regarding which underlying energy companies and MLPs have been able to weather the storm this year, we see upside for energy. A narrowing discount to NAV going forward would also drive an incremental return for investors. In the context of a diversified portfolio, a small allocation to some of the most speculative names may be appropriate.
Analysis and Forward-Looking Commentary
Entering Q4, the market environment has been defined by increased volatility compared to what was a steady levitation in asset prices through the summer. While the stock market is near its all-time high, there are renewed concerns regarding the strength of the economic recovery through next year including trends in the labor market as job gains appear to be slowing.
There is a sense that continued monetary support and fiscal stimulus are necessary until conditions can normalize looking ahead to a possible coronavirus vaccine in 2021. We expect headlines related to the U.S. election with policy implications and progress in passing a second-round stimulus package to continue representing risks.
In terms of equity CEFs, we have an overall cautious outlook with some of the leading sectors like technology and healthcare trading at stretched valuations. We expect returns to be more limited from the current level. We are constructive on energy with segment funds offering an attractive opportunity with a potential recovery in the pricing environment. Finally, we remain bullish precious metals, expecting a new all-time high for gold to be set over the next year.
We also believe CEF investors should begin paying attention to a recent climb in yields as it could pressure rate-sensitive market segments like fixed-income, preferreds, and convertible-bonds, reversing some of the positive tailwinds over the past year. For context, the 10-year treasury rate is currently at 0.80%, up from a low of 0.51% in early August. A move towards 1.0% could trigger fears of a more widespread bond repricing. CEFs which utilize leverage are exposed to potentially higher costs of funding at the margin which would manifest itself through narrowing premiums to NAV or wider discounts pressuring returns. There is a sense in the market that inflationary pressures could begin to manifest considering the record amounts of liquidity placed into the economy.
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Disclosure: I am/we are long ASA, BGR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.