NRGX - CEF Weekly Review: Is There Value In Knowing CEF Institutional Investor Holdings?

2023-10-09 05:40:03 ET

Summary

• We review CEF market valuation and performance through the last week of September and highlight recent market action.
• CEFs finished September on a weak note, with all sector NAVs moving lower as Treasuries and stocks fell.
• Investors should be careful in assuming some level of institutional ownership indicates a buy signal for a given CEF.
• CMBS CEF IHIT behavior has been unusual in its likely termination and is worth avoiding until its portfolio is mostly converted to cash.

Welcome to another installment of our CEF Market Weekly Review, where we discuss closed-end fund ("CEF") market activity from both the bottom-up - highlighting individual fund news and events - as well as the top-down - providing an overview of the broader market. We also try to provide some historical context as well as the relevant themes that look to be driving markets or that investors ought to be mindful of.

This update covers the period through the last week of September. Be sure to check out our other weekly updates covering the business development company ("BDC") as well as the preferreds/baby bond markets for perspectives across the broader income space.

Market Action

CEFs finished September on a weak note with all sector NAVs moving lower as both Treasuries and stocks fell on the week. Over the month, only Loans managed to finish in the green as credit spreads remain relatively well-behaved.

CEF discounts have widened in the last couple of weeks and remain wide by historical norms. Unimpressive returns and distribution cuts across the space have taken their toll, leading to a low level of investor sentiment for CEFs.

Market Themes

One metric various commentators like to focus on is the level of institutional ownership of various CEFs - something we saw with KIO recently. Intuitively, if there is a significant amount of institutional ownership in a given fund it could look like a winner for retail investors as well.

While this kind of piggybacking on the work done by professional managers can sound like a good idea, in practice it's very problematic. In short, this is a kind of lazy-man's version of investment analysis where there is comfort in failing conventionally, to paraphrase Keynes, than in actually doing the actual research yourself.

First, we don't know what the individual portfolios of these managers look like - they could be highly barbelled with a ton of very low risk assets together with a very low quality holding like KIO. In other words, knowing that KIO is held by some institutional managers tells us nothing about the actual exposure to KIO or the risk profile of any given portfolio.

Two, there is a lot of institutional ownership in most CEFs. If we look across the entire loan CEF sector we see most funds having institutional ownership around 30-40%. In fact KIO institutional ownership figure is only slightly above the average of the sector. Using this logic of institutional ownership suggests that investors should hold nearly all loan CEFs.

Three, there is often less than meets the eye in "institutional ownership" because a lot of this ownership is likely via private accounts of retail investors, many of whom simply ask the managers to buy and hold a given fund in their account. In other words people who take comfort in the institutional ownership metric are simply herding with other retail investors (even if those other investors are in the high net worth bracket).

Four, relying on someone else to pick where you put capital to work is a recipe for low conviction investing. Investors who don't understand why they own what they own (apart from the fact that someone else owns it too) are much more likely to suffer from damaging behavioral tendencies like selling at the bottom and buying more at the top.

Finally, using institutional ownership does not allow for individualized views of either market valuation or the economy. We don't know what the managers' risk appetite is nor what they think about the world - all we have is a kind of black box.

Ultimately, nothing beats doing the homework yourself, learning from the experience, having conviction and looking at funds in the context of your own risk appetite, views and personal situation.

Market Commentary

The behavior of the Invesco High Income 2023 Target Term Fund ( IHIT ) remains odd. Recall that this is a CMBS fund that is likely to terminate this year.

Over the last couple of months, the fund's NAV has underperformed that of IHTA (a 2024 version of IHTA) on the way down. The reason this doesn't make sense is that IHIT is a lower-beta fund than IHTA, not only because it has shorter-maturity securities, but also because it has been deleveraging steadily.

We can see this dynamic in the chart below where the IHIT NAV looks like a lower-beta version of IHTA until around June after which it keeps moving lower (while IHTA NAV rallies) and then dives sharply. The overall downward trajectory of the funds is likely due to the continued pressure on the CMBS market which the fund is primarily exposed to.

The only explanation for this change in beta to the downside that makes sense is that the fund has been paying wide bid/offers to get rid of its holdings and this has been pushing the NAV lower. As of end-July IHIT has fully deleveraged and has around 15% in cash.

This is not typical of CEFs - if you look at the behavior of other CEFs that wound down, this is not the kind of behavior you tend to see at all. NAV just tends to flatline rather than move lower even for funds that hold less liquid securitized assets (e.g. JMT).

Given this unusual dynamic in IHIT it will only be a compelling tactical hold once it sells down almost all of its assets which we will know from its fact sheet.

Stance And Takeaways

Over the last couple of months we have focused on relative value and tactical ideas across the CEF space, both having a good amount of success. On the tactical side, we have already seen significant gains in FS Credit Opportunities ( FSCO ), Carlyle Credit Income Fund ( CCIF ) and the PIMCO Energy and Tactical Credit Opportunities Fund ( NRGX ), all of which have been highlighted earlier. And though there is less upside from current levels, we continue to view these funds favorable in tactical terms.

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