CET CEF: A Steady Whirlwind Outperforming (NYSE:CET)

thesis

The Central Securities Corporation (NYSE:CET) is about as boring as a stock CEF can get. It lacks the glitz and glamor of tech investing, the untapped potential of private funds, and the drama associated with crypto exchange stocks. But boring can be very profitable, especially when the “boring” outperforms the S&P 500 with the same volatility analyses.

We tend to cover CET annually as it is not a structurally changing name and will revisit the name after our last fund article appears in 2023.

No monthly distribution? No problem

One of the features that retail investors enjoy immensely around equity CEFs is the monthly distribution. Equity CEFs convert stock returns into dividends, and managers tend to distribute those returns monthly. CET does not, with only two dividend dates per year:

The fund has a distribution in June that pays $0.2/share and a variable distribution date in November that fluctuates based on fund performance. To better understand how variable distribution works, let’s take a look at CEF’s historical NPV figure:

Unlike many CEFs that have very stable NPVs over the long term, CET likes to see a steady increase in net asset value. This means that its variable distribution in November is always less than what the fund actually makes, thus having a cumulative effect on net asset value.

We like the fact that CEF has not succumbed to the marketing mania of monthly distributions and continues to do what it does best and increase its NAV as it goes.

Beating the S&P 500

Despite many criticisms over the years that CET management is just cutting fees, CEF has proven itself over the past year by outperforming the S&P 500 from a total return perspective:

Although small, the outperformance speaks volumes for the management team’s ability to justify its existence. Would prefer to take CET over monthly paying CEFs that incorporate many bells and whistles but fail to outperform or even match SPY’s performance.

Don’t expect the discount to narrow

As I mentioned in the thesis section, CET doesn’t change much structurally, so the market doesn’t fluctuate significantly when it comes to discounting it to NAV:

A -16% discount to NPV is the break-even level for this name, with the fund set to benefit from a -20% discount on the back of significant de-risking events and heading for -10% during the global market meltdown .

This feature is not very tradable for the name because the moves occur over long periods of time and are associated with tail risk events.

He owns a large private insurance company

What is very special about CET, and an aspect that has been passed over in recent years in the financial press, is CEF’s ownership of Plymouth Rock:

Over 24% of the fund’s assets are held in this name, and potential investors need to be very comfortable with the insurance business line and more illiquid holdings.

We like the way CEF spells out the holding period for its top names, as it shows true buy-and-hold intent for companies that will scale. Plymouth Rock has been around since 1982 and has proven to be a consistent compound for the name. Expect this company to be around in the near future, and as a CET investor, you need to be comfortable with this line of business:

Plymouth Rock, founded in 1982, is a privately held insurance company that writes personal and commercial lines of business in the northeastern United States.

Please note that another famous buy and hold company, namely Berkshire Hathaway, has owned the insurance company GEICO since 1999.

Expect CET to continue to be a buy-and-hold fund, with portfolio turnover from Morningstar speaking for itself:

The reported turnover in December 2023 is 4%, which is weak compared to other equity CEFs.

Biggest risk factor – insurance and finance

While CET has proven to be a true “Steady Eddy” in recent years, investors must recognize the inherent risks associated with the name holding a large illiquid stake in an insurance company and the overall financial/insurance focus:

Insurers and Financiers account for over 40% of the fund’s holdings, thus representing the biggest risk factor for the name. The current base case in the market, namely a soft landing, represents an ideal macro environment for those sectors.

The worst-case scenario for the fund is a severe recession, where consumers can’t pay their dues, prompting major financial companies and insurers to take loan-loss provisions and hit their book values. Currently, such a scenario is remote, but it is the biggest risk factor for this name.

Please note that even if a mild downturn were to occur, the fund has some flexibility in where it marks its Plymouth Rock position, which is classified as a Level 3 asset:

Level 3 assets are those instruments that are not traded. Thus, market participants rely on observable data to determine a price:

Level 3 securities are instruments that are not traded on the market. As such, no observable market data is available for the instrument, requiring the use of significant unobservable inputs.

BDCs and other entities that hold privately traded loans are notorious for being able to show resilient ratings even when the liquid, HY-traded market faces deleveraging crises. The take home point here is that fundamentals matter more than short-term events when valuing items like Plymouth Rock.

Conclusion

CET is a closed-end equity fund. The vehicle is the definition of a “Steady Eddy” equity CEF and has managed to remain “boring” over the years with only two distributions per year, one of them variable. The fund is a rare breed in that it targets a growing NAV and has managed to slightly outperform the S&P 500 over the past year. Vehicle discount to NAV does not fluctuate much and is not an easy feature to trade for shorter trades. CET continues to deliver in a steady, boring fashion and has all the makings of a true buy and hold name. In our annual review of this CEF, we are still a “Hold” on the name.