Hi All, I was wondering if anyone here can explain or point me to some resources regarding how to analyze and value closed-end funds. Specifically, thanks to a tip from a fellow AFer, I invested in the Eaton Vance Floating-Rate Income Trust (EFT) about a year ago. I can’t find the original post, but someone here posted the recommendation so I decided to act on it. Since then, I’ve seen shares soar by close to 50%. This is really an example of how I trusted someone else’s rationale and reasoning, and decided to act on the basis of that (as opposed to my own due diligence). I’m very fortunate it worked out this way, and our AF peer definitely knew what he was doing. My question is, can someone explain how an “Average Joe” like myself can search for and analyze other closed-end funds to identify other interesting opportunities? Does anyone else here have specific thoughts on EFT?
What exactly are you trying to analyze them for? The big thing about CEFs is that they can trade at a premium or discount to NAV. So first you have to figure out what NAV is, and figure out what you think NAV will do given the rules or strategy of the fund vs the general economic environment. Then you have to ask yourself how the discount or premium is likely to change over time. I don’t follow CEFs, but my guess is that as the financial crisis has moved from a true crisis to recuperation, a lot of CEF discount-to-NAV diminished, so the underlying assets probably participated in the rally (assuming it’s a stock fund), and then you got a boost as the discount to NAV diminished. There’s not a lot of literature or understanding about why CEFs should trade at a price different from NAV (other than accumulated fees). My take is that if you think the manager is an idiot and will underperform a buy and hold strategy of those same assets, you would definitely want to discount it - for example, someone who adds no value but overtrades will underperform just holding those assets and so the fund should have a discount. Similarly, if you think the manager adds value, then you would pay a premium, much in the same way that a company’s earnings power ought to make it worth more than simply the value of the physical assets it owns. The other explanation that seems likely is just the supply and demand for publicly available managers with a particular strategy. So if we have a CEF that invests in distressed firms, and lots of retail investors suddenly decide that that’s the strategy-du-jour to be in, then the supply and demand will affect the discount/premium. However, if there are open-ended funds with the same strategy and no clearly better manager, then there should be some kind of rough-arbitrage opportunity.
EFT is still a decent play since it should (in theory) adjust to rising LIBOR when the Fed starts bumping rates up in 2-3 quarters.
Numi- over half of my portfolio is made up of CEF’s. Like noted above- a CEF and trade at a premium or discount to NAV- unlike a mutual fund that creates/redeems shares @ the NAV. Another difference is that there are no loads/breakpoints to consider. All you pay to trade is the commission. The reason I got so heavy in these things is that I was almost all cash before the collapse and CEF’s took a far greater hit relative to their underlying NAV’s relative to straight equities and or FI instruments. There are a lot of reasons for this- since there is fixed limited pool of shares there is more of a liquidity trap so clearly they suffer more in a panic. Furthermore many CEF’s are highly leveraged and must abide by laws regulating the ratios they can reach. When asset prices fell all went over the allowable ratios and that created even more of a panic and forced them so start dumping their assets to get back into compliance- so they were forced to sell into a down market… pretty bad for those who owned before the collapse, but this snowball of price depressing factors made them increadible buys at the time. Now most are levered via Auction preferred securities that are rolled on some basis. During the crisis auctions would fail and that would be more of a down force on the CEF market pricing bc there was a credit crunch but it was ironically better for some of my funds since a failed auction meant the lender was stuch and would receive some reference rate- many were fed rate + nothin so you can imagine how cheap the leverage was! Now that things are back to normal all the different factors that forced prices down have reverted back to average- the actual underlying being only one of them. In the aftermath original owners could never recoup their losses as assets had to be sold off- but from valley to today the survivors have jumped more in value than the underlying assets. As far as analysis take into account leverage- even if its a equity fund you have to pay attention to the FI market if the fund is using a lot of leverage. Also look at the management and historical premium/discount to NAV trends (all of which whose managers have on their websites). Also look at the quarterly holding disclosures/ turnover ratio’s and such. They have their mandates but you can look at the underlying to verify if their execution agrees with your views.
What is a good way to evaluate their leverage ratio? Also, is there a way to tell if any percentage of “income” is just distributing capital back to shareholders? Also, what kind of documents/filings do you need to look at for these things? I am used to open-ended funds with prospectuses and semi-annual reports, but CEFs seem to lack these since they are treated like a normal brick & mortar corporation. Should I be on EDGAR trying to look up a 10k?
All CEF’s should trade at a discount due to the management fee - if a CEF’s value is simply a DCF of the future cash flows of the individual investments, you must do a DCF of the management fee. Depends on the fee but I wouldn’t look at anything with a discount of less than 8% or so. One other point numi, just about anything you could have put money into about a year ago has gone up at least 50%.
newsuper Wrote: ------------------------------------------------------- > All CEF’s should trade at a discount due to the > management fee - if a CEF’s value is simply a DCF > of the future cash flows of the individual > investments, you must do a DCF of the management > fee. Depends on the fee but I wouldn’t look at > anything with a discount of less than 8% or so. This implies that the fund manager can’t add the slightest value through his management and the collateral inside the fund is also easily accessible for anybody.
Klarsolo Wrote: ------------------------------------------------------- > newsuper Wrote: > -------------------------------------------------- > ----- > > All CEF’s should trade at a discount due to the > > management fee - if a CEF’s value is simply a > DCF > > of the future cash flows of the individual > > investments, you must do a DCF of the > management > > fee. Depends on the fee but I wouldn’t look at > > anything with a discount of less than 8% or so. > > This implies that the fund manager can’t add the > slightest value through his management and the > collateral inside the fund is also easily > accessible for anybody. Isn’t that what EMH tells us?
Thanks for the detailed feedback, especially bchadwick and akanska. I’m sure I’ll have some follow-up questions once I’ve had a chance to digest some of this information.
newsuper Wrote: ------------------------------------------------------- > All CEF’s should trade at a discount due to the > management fee - if a CEF’s value is simply a DCF > of the future cash flows of the individual > investments, you must do a DCF of the management > fee. Depends on the fee but I wouldn’t look at > anything with a discount of less than 8% or so. > > One other point numi, just about anything you > could have put money into about a year ago has > gone up at least 50%. Thats to rational- not everyone has access to everything- look at some of the PIMCO funds and their premiums. There are momentum swings for certain funds that can push premiums way up. As far as the anything would be up 50%- yeah thats true- but w/ their leverage most CEF’s either died or are up WAY more. On the other side though most fell way more than the market did over the crisis. My point was simply to illustrate that they are often more risky than simply looking that the underlying. For example two of my funds are STILL down 80/85% from their peak. But they are up 425/300% from bottom.