For many closed-end funds, the realization that borrowing costs could potentially rise in the near future hasn’t been met with a smooth transition. In fact, the majority of funds on my watch list have suffered a great deal as individual investors fret over the unknown, and choose to “de-risk” instead of hanging in there to see what ultimately happens.
I’m reminded of the 2013 taper tantrum as the next closest example to fiscal tightening. In that particular instance, rates shot higher unexpectedly once the announcement was made, but after quantitative easing eventually began to tail off, it was a positive result for bond holders. I’m inclined to believe we are headed for a similar outcome for CEFs and other risk assets, since the bottom line is that the Federal Reserve’s confidence in the economy isn’t unfounded. Naturally employment statistics are a key driver, but the economy has gotten undeniably stronger; the tough part now is following along closely to ensure that strength endures.
With all of the recent volatility stemming from the August-September equity correction, there have been several bright spots, or funds that have largely bucked the herd’s trend and stayed relatively buoyant. I want to highlight these funds because it’s important to own contradictory assets to bolster stability within a relatively volatile portfolio of CEFs. Owning a mix of funds that are dominated by one particular theme will be doomed to languish in an unfavorable environment.
The three funds include the Flaherty and Crumrine Dynamic Preferred and Income Closed Fund (N:DFP), the Pimco Dyn I (N:PDI), and lastly the Doubleline Opportunistic Credit (N:DBL). Each fund has managed to tread water despite a tough equity market, fundamental headwinds, and belonging to a much larger constituency of under performing CEFs.
The most surprising observation about this trio of funds is that they share very little in common with each others portfolio strategy, management style, or leverage characteristics.
For example, DFP has been able to hold its own as a result of asset class appreciation; where preferred stocks have large led the pack in comparison to other high income assets. This is likely a result of the improving fundamental backdrop of our nation’s banks and insurance companies, of which most preferred stocks are issues by.
Conversely, PDI is a “go anywhere” fixed-income fund that has been able to sidestep the credit slowdown by investing primarily in emerging market bonds to solidify its strong underlying portfolio cash flow. Yet you can also attribute much of the low day-to-day NAV fluctuation to the derivative overlay PIMCO implements to control credit, currency, and interest rate risk. Furthermore, PDI continues to be one of the best performing CEFs year-over-year, and as a result has earned a permanent place within many investor’s portfolios.
Lastly, DBL up until recently was one of the frontrunners as a result of its relatively long duration of roughly 9 years. In addition, DBL’s mandate alongside Jeffrey Gundlach’s portfolio management style has kept DBL from becoming over-invested in less credit worthy non-agency mortgage backed securities. As a result, DBL caries nearly half of its portfolio in long dated investment grade Ginnie Mae mortgages, backed by borrowers of the highest credit worthiness. As interest rates fell during the equity correction, DBL’s market price rocketed higher back to a healthy premium above its NAV.
The one trait that each of these funds do have in common is that they are all holdings within our Dynamic CEF Income Portfolio, which seeks to invest in funds with strong fundamentals and superior portfolio construction. As you review your CEF holdings, be mindful to balance and diversify among asset classes and management styles. This will insulate the effects of a singular underperforming fund or fund sponsor. Taking the time to investigate the details of each fund is important to understanding how it can complement your portfolio in an otherwise tough situation.
Disclosure: FMD Capital Management, its executives, and/or its clients may hold positions in the ETFs, mutual funds or any investment asset mentioned in this article. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.