Discount Double Check in CEFs

Closed-end funds are currently trading at a discount as equity markets have dropped. Here’s where to spot opportunities.

The Dow Jones Industrial Average just closed out its worst first quarter on record, after a dropping 23% since the start of the year1. The selloff has disproportionately affected equities relative to bonds, potentially resulting in an overweight to bonds in investor portfolios – and potential bargains for value investors.

We believe investors should consider rebalancing back to their strategic equity allocations. As you look to re-allocate to equities, today’s post focuses on equity closed-end funds (“CEFs”) and seeks to differentiate between what we believe are “value opportunities” and “value traps”.

Focusing on the long term

CEFs effectively have two values for investors to evaluate. One is fund’s net asset value (“NAV”), or the aggregated value of its underlying holdings. The other the market price of the CEF itself as it’s traded on the exchange. In the recent equity decline, CEF market prices have generally fallen more than their respective NAV’s as investors sought to de-risk their portfolios. We believe this presents a unique entry point for long-term investors to buy equity securities at a “discount” to their current market value and be well positioned when markets recover with time.

Additionally, our research shows that CEF discounts tend to mean-revert to historical averages (exhibit 1).