2023-06-21 05:33:33 ET
Summary
- The Invesco CEF Income Composite ETF (PCEF) is an aggregator of closed-end funds (CEFs) and has a high 30-day SEC yield of 8.85%.
- PCEF's performance is driven by the underlying funds' risk factors and their discounts to NAV, with a beta to risk-off events.
- The author believes the current market rally is unsustainable and recommends selling PCEF now to pick it up 15% lower later in the year.
Thesis
The Invesco CEF Income Composite ETF ( PCEF ) is an exchange traded fund. The vehicle is an aggregator, holding only CEFs, and mirroring the S-Network Composite Closed-End Fund Index:
The Invesco CEF Income Composite ETF is based on the S-Network Composite Closed-End Fund Index SM (Index). The Fund will normally invest at least 90% of its total assets in securities of funds included in the Index. The Fund is a "fund-of-funds," as it invests its assets in the common shares of funds included in the Index rather than in individual securities. The Index currently includes closed-end funds that invest in taxable investment grade fixed-income securities, taxable high yield fixed-income securities and others that utilize an equity option writing (selling) strategy. The Fund and the Index are rebalanced and reconstituted quarterly
An investor with a passive CEF investment approach can just buy an aggregator such as PCEF rather than pick individual CEFs. The vehicle tracked the S&P 500 fairly nicely off the October lows:
We can see a divergence in performance only starting in April, with the S&P 500 moving higher on the back of an outperformance in a handful of mega-cap tech stocks. PCEF therefore exhibits a nice beta to the Index, but with a high dividend yield. The fund has a high 30-day SEC yield of 8.85%, but keep in mid the fees here are very brutal:
Fees (Fund Fact Sheet)
An individual investor just replicating the portfolio outright can save almost 2% in fees here. Long term these high fees eat into the fund's returns.
In our view the best utilization for this fund is as an easy CEF aggregator on macro moves - a retail investor feeling the CEF discounts to NAV had widened too much in October 2022, could have just bought PCEF rather than pick individual names. The market was oversold, both for fixed income and equities, and PCEF would have been an easy entry into a diversified CEF portfolio.
There are two components to CEF returns:
- Risk factor drivers by the underlying asset class in the funds (equity returns, fixed income returns)
- Widening/narrowing of discounts to NAV
CEFs usually have a certain beta to market risk-on / risk-off moves in terms of discounts, with funds experiencing widenings when the market is in a risk-off mode.
Current market and PCEF positioning
In our opinion we are currently experiencing euphoria in the equities market:
Fear & Greed Index (CNN)
As the CNN Fear and Greed Index illustrates, we are experiencing Extreme Greed. The equity market has rallied hard, but not on earnings growth but on P/E multiple expansion. In effect, seven stocks have carried the index:
Market Factors (Desant Capital)
This type of price action is not sustainable, and rather than see a new bull market being born, we are of the opinion we are going to experience a correction. Most bull markets exhibit breadth in terms of stock gains. This means that most of the market needs to participate in the bull run. The current environment is not showing breadth, but actually a very narrow move up in a handful of large capitalization stocks.
On the fixed income side we have seen high yield spreads retrace a lot of the widening seen in the market sell-off late last year:
In fact we are almost back in spreads to the same levels as in April 2022, despite a massive monetary tightening done by the Fed. Default rates are picking up, and we think they will keep increasing. We are not done here with this recessionary cycle and we are going to have a VIX event with lower equities and wider credit spreads.
As discussed above, most CEFs have the propensity to see their discounts widen on the back of risk-off events. This will translate into a 'wrong-way' risk event for PCEF, where not only will the assets trade down in price due to their primary risk factors, but they will also move lower on the back of widening discounts to NAV in the underlying CEFs. That means that PCEF will sell-off harder than the wider market on the back of a significant risk-off event.
We think right now a retail investor should not consider entering PCEF, but actually exiting.
Holdings
The fund currently holds 117 individual CEF names, from a cross-section of sectors:
Composition (Fund)
As we can see from the above graph, around 51% of the portfolio is composed of fixed income CEFs, while around 40% falls in the equity buy-write space. So we can consider the overall vehicle as being tilted towards fixed income.
The top names in the fund are tickers and names which are familiar to any CEF investor, with most of the funds being covered by us on this platform:
The Eaton Vance Tax-Managed Global Diversified Equity Income Fund ( EXG ) is an international stocks buy-write CEF for example. So in the above table it would fall in the 'Option Income' sector. On average the portfolio holdings are trading at a weighted average discount of -7.5% currently.
Performance
We can see PCEF's performance closely mirroring the S&P 500 until the outperformance of mega-cap tech earlier this year:
The fund has embedded leverage via its holdings, and although it has a fixed income tilt it does have a significant equity allocation as well. Outside the tech mega-caps which have outperformed, we expect PCEF to closely follow the index in a recovery.
Conclusion
PCEF is an exchange traded fund that holds only CEFs. This structure gives it an aggregator profile. The fund currently holds 117 individual CEF names, and has a fixed income tilt via its portfolio. Currently around 51% of its portfolio is composed of fixed income CEFs, while around 40% falls in the equity buy-write space. PCEF's performance is driven by the underlying funds' risk factors and their discounts to NAV. We have observed a beta to risk-off events in the cohort, with most CEFs experiencing wider discounts when the market sells off. This will translate into PCEF selling off harder when the market tanks. We are of the belief the current rally is not the start of a new bull market, and the S&P 500 is currently driven by only a handful of stocks which are seeing their P/E ratios expand. That is not a sustainable story, and it will reverse course. Similarly, in the fixed income space, spreads have come down to their April 2022 levels despite the significant monetary tightening. We are expecting a market sell-off next, where PCEF will move lower faster as the underlying CEF discounts also widen. Sell this name now to pick it up 15% lower later in the year.
For further details see:
PCEF: Is It A Good Time To Enter This CEF Aggregator? We Think Not