CEF Weekly Review: Distribution Increases Not Working

Welcome to another installment of our weekly CEF Market Review, where we discuss closed-end fund (“CEF”) market activity both from the bottom up – highlighting individual fund news and events – and from the top down – providing an overview of the wider market. We also try to provide some historical context as well as relevant themes that appear to be driving the markets or that investors should be aware of.

This update covers the period up to the last week of August. Be sure to check out our other weekly updates covering the business development company (“BDC”) as well as the preferred/baby bond markets for insights into the broader income space.

Market action

CEFs have recovered from their early August pullback and then some. All CEF sectors ended August in the green, with higher-beta MLPs and REITs leading the way.

August ended on a par with the previous three months. Since last October, there has only been one down month.

From a total return perspective, CEFs have now recovered their post-2022 draws.

Cuts in the fixed income CEF sector continued to tighten, while cuts in the equity CEF sector lagged behind. CEF fixed income sectors are now firmly in expensive territory.

Once we factor in both credit CEF cuts and underlying credit spreads, we can see that we are very close to the level of overvaluation at the end of 2021. Overall, this picture suggests that credit CEFs, in total , does not present an attractive value proposition. That said, there are key differences between today and the end of 2021 – namely that leverage costs will be falling rather than rising, and interest rates are still relatively high.

Market Themes

AllianceBernstein Muni CEF AFB increased distribution by 10%. Remember that Muni CEFs have been making distributions left and right, especially those managed by Nuveen, Eaton Vance, BlackRock, Invesco and Western Asset. However, not all managers attended, with AB and BNY Mellon notably absent. This resulted in a large difference in distribution levels.

Interestingly, distribution differences say nothing about cuts, despite managers’ hopes that raises would tighten cuts. Looking at the relationship between distributions and discounts for unlevered CEF Muni, the R^2 is 1% in the “right” direction (ie, higher distributions are associated with tighter discounts), which statistically implies no relationship . To date, the reduction compression of the Muni CEF sector has exceeded that of the medium sector. Maybe the increases helped the overall sector, but not the specific funds that went up.

Market Commentary

Remember that Bill Ackman couldn’t get enough people to buy into his CEF PSUS IPO because most people correctly expected the fund to trade at a discount afterward. This creates a bootstrapping problem for the fund, as no one wants to be the one to sacrifice their capital by buying shares at NAV so that secondary market investors can buy the fund at a discount. The easiest way to get past the deadlock is for Ackman to put in some free money. From an economic point of view, it could still be a win, as it will recoup the money over time through commissions. Another option is to put into the pot warrants or shares of the management company Pershing Square. That might be enough convincing for everyone to bring the IPO back to life.

Tender offers for the BlackRock discount program flew last week. Proportional figures ranged from 6% for MVF to 27% for BME. At its peak, it delivered an annualized alpha of 6%. Also, remember that the Eaton Vance Muni EIM fund had a tender offer in July, and it had a staggering 47% leverage factor. At this point of the two Muni funds, EIM is more attractive than MVF, even though it has a smaller number of annual offerings. These conditional offering programs allow investors to generate an attractive amount of alpha in a rather unattractive beta environment.

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