NMAI - CEFS: The Best Closed-End Funds To Buy For 2024

2023-12-07 18:01:15 ET

Summary

• Saba Capital, founded by Boaz Weinstein, has won industry awards and focuses on activism to close discounts in closed-end funds.
• The Saba Closed-End Funds ETF aims to generate high income and currently yields around 9%.
• CEFS has a history of solid positive returns and should outperform similar products in the future due to their very active approach.
• The demand/supply outlook also is favorable for closed-end funds in 2024.

About Saba Capital

Saba Capital was founded in 2009 by Boaz Weinstein. He was on the successful side of a trade against the "London Whale" trader from JP Morgan, who racked up huge losses in 2012. This assisted in helping the firm obtain growth in AUMs.

Their main strategies consist of Credit Relative Value, Tail Hedge, Closed-End Funds and SPACs. The Saba Closed-End Funds ETF ( BATS:CEFS ) is an ETF that seeks to add value by investing in closed-end funds. It uses proprietary models in an active strategy by trading closed-end funds to benefit from the widening and narrowing of their discounts to NAV.

Boaz Weinstein and portfolio manager Paul Kazarian have focused on activism as a tool to close discounts in closed-end funds. There have been many high-profile activist campaigns in 2023 from them.

Saba Capital has won industry awards recently such as the 2023 Activist Hedge Fund Manager of the Year and Credit-Focused Hedge Fund Manager of the Year.

CEFS Overview

CEFS aims to generate a high level of income with this process and is prepared to take quite concentrated positions at any time. Currently, the ETF is yielding around 9%. From an asset class point of view though, it splits its exposures approximately 50% between equity and fixed income. The most recent factsheet at the time of writing shows the fund using a modest leverage of 14%. The portfolio's overall average discount to NAV was at 13.9%.

Importantly though investors should note that Saba may hedge out such interest rate risk or market risk where it believes it is prudent to do so. The appeal of the Saba strategies is often more about the attractive risk/return characteristics of achieving the narrowing of the discount to NAV.

This ETF has net assets of circa $145 million with the fees and expenses it charges running at about 1.2%.

The total annual fund operating expenses though are listed as 2.9%. The difference between these two measures is that the 2.9% also includes the indirect fees that occur because of this fund of funds approach. That is, you are effectively indirectly incurring additional fees from the underlying holdings of funds that have their own fees.

Whilst the instant response from some might be to avoid this product as soon as they see this 2.9% figure, the response should be more nuanced. If Saba Capital demonstrates they can benefit from the narrowing of the discounts on the funds they own to a significant extent, this can offset such indirect fees.

The high yield is a prominent feature above. Their past performance since inception almost matches the current yield on offer. With the outlook being more promising for closed-end funds heading into 2024 though, the near double-digit yield on offer is sustainable.

CEFS history and past performance

CEFS began in March of 2017, and the below table illustrates the performance figures updated to the end of November.

We can see from the performance figures that there have been some solid positive returns since inception. I use the description as solid in the context of some of the risk mitigation strategies I alluded to earlier. For example, with the fund generally being only half exposed to equities during this time. It also avoided some of the pain in fixed income markets in more recent times by shorting interest rate derivatives.

If one therefore is looking for consistent positive returns with a lower correlation to equities, then this ETF is well worth some consideration. Even more so, given that closed-end funds in general are trading at historically wide discounts to NAV.

How to judge the performance of CEFS?

Considering their investment style, I would not necessarily expect them to match the S&P500 in the very long run. That is, CEFS will often hold half the fund in fixed income exposures and hedge out plenty of underlying market risk.

I would be looking at CEFS as an investment to provide relatively stable positive returns over the medium term. It should also give you high and consistent distributions, with lower drawdowns. I would also be expecting that Saba Capital demonstrates their skill in closing the discounts of closed-end funds they own. They have demonstrated that in the past and I would expect this ETF to outperform similar products again in the future.

Let's consider some similar funds that invest primarily in closed-end funds.

The CEFS ETF stands out in a positive relative sense.

Ultimately though whether you want to invest in CEFS going forward comes down to whether you want to back Saba Capital's active trading strategies, led by Boaz Weinstein. Another key point is whether you believe there is good value in the closed-end funds space more generally.

Saba Capital's other listed product - recently targeting ASX & LSE funds

Saba Capital also has another listed fund, the Saba Capital Income & Opportunities Fund ( NYSE:BRW ), that is a closed-end fund. This may be the better option to get exposure for those activism campaigns potentially starting in Australia and the UK . They must like their ultimate chances with targets just mentioned there such as VGI Partners Global ASX and European Opportunities Trust LSE. Without doubt performance has been very poor over long periods in those cases.

Whilst BRW only had 15% exposure to Australia / UK according to their website , this was back in July. Given the stories linked to above, plus stock exchange filings since, I am expecting this to be more now.

Those that see more upside in Saba's top US holdings in CEFS (which I shall explore later in this article) may prefer Saba's ETF.

With an ETF like CEFS, you don't have to worry that it weakens to a large discount to NAV itself. It is not unheard of that activists may come under pressure themselves in regards to their discount.

In Saba's case though, I have noticed the BRW discount to NAV has contracted somewhat since my article last month . It has tightened from 12% to about 8% over that period.

I have also warmed to CEFS as being a good pick for 2024, due to their total focus being on closed-end funds. BRW has been actively moving their weights towards closed-end funds and reducing exposure to SPACs over the last year. BRW takes a more dynamic approach to allocations to different security types and holds less of that portfolio in closed-end funds.

Saba Capital via a recent deal, is also the new investment advisor at Templeton Global Income Fund ( NYSE:GIM ). It is still relatively early days in this transition, but those who rate Saba Capital highly should keep an eye out on that one also.

Closed-end funds as a source of alpha in 2024 in a challenging year for beta

Whether there are easy gains to be had on stocks and bonds in 2024 remains to be seen. Equities though are faced with the challenges of high valuations and worrying economic leading indicators.

The leading indicators seemingly point to lower interest rates ahead but returns in bonds may be limited by "sticky" inflation as a result of supply-led factors.

In such an environment, owning a closed-end fund in 2024 where the discount for example contracts from 20% to trade in line with NAV is attractive. In percentage terms (20/80), that is actually a 25% return. The exciting part about that is in some cases it can be achieved completely independent of what the market or overall economy is doing.

Of course, I have made it sound overly simplistic above. I point this out however, because of the ideal time we are at in terms of overall large discounts to NAV. As I shall explore, we also looked primed for catalysts from shareholder activism, a key tool to close the discounts.

Closed-end funds to benefit from likely lower interest rates in 2024

With leading indicators suggesting we may get some downward pressure on interest rates; this removes a headwind for closed-end funds from 2023.

Closed-end funds often use leverage within their strategies. Higher than expected interest rates over the last year or two have negatively affected not only their funding costs but also sentiment towards them.

Retail investors often seek closed-end funds for high yielding regular income. Higher interest rates have therefore also made them comparatively less attractive in recent times to government bonds or cash.

The higher interest rate theme has contributed to discount widening in the last couple of years, but sentiment is poised to change in this regard.

Why closed-end funds are cheap right now

CEF Discount Stats suggest that at the time of writing discounts have rarely ever been wider than now. The main exceptions when discounts were wider were around the 2008 financial crisis and more recently the "covid crash" of 2020. Decades of data in the link just provided suggest that discounts have only been wider 5% of the time compared to now.

One logical response to that is that does this really help too much if there are no catalysts for discounts to tighten?

In that regard though the prospects for discounts to tighten in 2024 look good due to catalysts from activism campaigns.

Closed-end fund activism campaigns likely to surge again in 2024

The three main closed-end fund activists have already substantially increased their activism in 2023 from the two years prior years.

At the same time though, the number of campaigns is relatively modest when we consider the numbers over the last few years.

We can see those years such as 2010, 2011, 2017 2019 2020 were far busier with activism campaigns.

With discounts currently so wide, 2024 looks like a promising year for discounts to narrow because of shareholder activism.

To capitalize on this, investing with a manager who has been more active in this area is ideal. As we can see from the chart below, Saba Capital fits that description.

The above commentary on the chart also notes how supply has been discouraged, another positive argument for discounts to narrow in 2024.

Turning to the demand side of the equation, it can't hurt that Saba Capital seems keen on investing more money into closed-end funds. As mentioned earlier they have also taken over the management of the Templeton Global Income Fund.

CEFS holdings and prospects

With CEFS often taking quite concentrated positions in other funds, it is worthwhile spending some time looking further at the top positions. Below I have provided quite brief comments on the top 5 positions at end of November.

BlackRock ESG Capital Allocation Term Trust ( NYSE:ECAT ) - This has already seen its discount contract from around 15% to closer to 10% lately. I don't foresee the discount getting back out to those wider levels because Saba has been very public with their campaign against BlackRock . This BlackRock Trust as the name suggests is already structured so that investors can tender their shares at NAV at a specified date, in this case in 2033. It is quite well diversified with an approximate 70/30 split between equities/bonds.

With the publicity that is being generated such as in the link just above, and given Saba continues to increase its holding here , we may see action sooner rather than later.

ClearBridge Energy Midstream Opportunity Fund ( NYSE:EMO ) - This has mostly traded at around a 14% discount to NAV throughout 2023. Saba, just a few months ago, called out this fund for its alleged disregard of the rights of voting shareholders .

To quote specifically, " Saba is committed to pursuing all available paths to continue to defend the rights of closed-end fund shareholders at EMO going forward, and we call for the full board to resign effective immediately ."

Reading the above news story, I see catalysts for a closing of the discount in this situation.

Nuveen Multi-Asset Income Fund ( NYSE:NMAI ) - Another Saba top holding that has spent 2023 mostly trading around a 14% discount to NAV. Also yet another example of Saba still continuing to accumulate stock very recently , and one where they own well over 10% in. A very broadly diversified fund with underwhelming performance, one where Saba can easily argue for some necessary changes.

Saba only last week, commented on a successful outcome of a lawsuit against Nuveen . We shouldn't underestimate the broader implications this may have for the future of some other closed-end funds. To quote Weinstein directly here " This ruling reinforces that Nuveen and other closed-end fund managers are violating the law by implementing illegal vote-stripping provisions to disenfranchise shareholders and entrench their boardroom pawns. Closed-end fund trustees should reconsider the caliber of the legal advice that they have been receiving, and should spend less time and shareholder capital on meritless battles and more on improving performance ."

BlackRock Capital Allocation Term Trust ( NYSE:BCAT ) - This is another Saba holding where they own more than 10% of the Fund's stock. The underlying holdings are roughly split equally between equities and fixed interest at the present time. Fortunes here are likely tied to how Saba fare with their campaign against BlackRock as I mentioned with their largest holding above.

Neuberger Berman Next Generation Connectivity Fund Inc ( NYSE:NBXG ) - This discount here has averaged approximately 18% in 2023. It provides exposure to technology stocks with an additional strategy of writing covered calls against some of them. Its biggest problem was that it launched in mid-2021, therefore the first 12 months of its life was a terrible time generally for technology stocks.

Conclusion

CEFS is an attractive high yield investment heading into 2024 with discounts on closed-end funds historically wide. There are catalysts for this to change in the way of declining interest rates, increasing shareholder activism, and favorable demand/supply outlook in closed-end funds.

Positioning yourself in a specialist activist manager such as Saba Capital is a sound way to play this theme. Alpha from closed-end funds discounts narrowing looks very attractive versus beta offered from equity and bond markets at this time. It is therefore better to let Saba Capital choose the best closed-end funds for 2024 to gain exposure from this trend.

The main risk I see to CEFS is if we see interest rates continue to head higher than expected. Another risk could be if some of the activism campaigns get drawn out or are unsuccessful. Discounts may then continue to remain wide, and the CEFS performance will also be weighed down by the fee structure.

Such a rising rates scenario though may also be quite unwelcome for passive exposure to equities and bonds in 2024 anyway. With that backdrop, CEFS may even still be a relatively good ETF to own.

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