Closed-end funds finished the quarter down following persistent inflation and continued talk of monetary policy tightening.
Closed-end funds had a market-price return of –6.2% in the third quarter, as measured by the S-Network All Taxable ex- Foreign plus Capped Muni CEF Index,1 bringing the year-to- date return to –23.6%. By comparison, the S&P 500 Index2 and the Bloomberg U.S. Aggregate Bond Index3 had total returns of –4.9% and –4.8%, respectively, for the quarter, and –23.9% and –14.6% for the year to date.
Closed-end funds finished the quarter down following persistent inflation and continued talk of monetary policy tightening. The quarter represented two tales, however, with the first half rallying on belief weakening data would slow rate hikes. This belief gave way near the end of August amid healthy economic data reports when Federal Reserve Chair Jerome Powell stated the Fed would continue to aggressively fight inflation by raising rates despite the potential for economic pain. Rising rates and expectations for additional rate hikes pressured stocks broadly and pushed the yield on the 10-year U.S. Treasury note from 3.0% to 3.8%.
Nearly all closed-end fund sectors declined in the quarter on both a market price and net asset value basis. Within fixed income, investors favored sectors that generally invest in shorter-duration securities, led by bank loans (–2.8% total return on market price) and high-yield bond funds (–4.4%). In the rising-rate environment, longer-duration securities underperformed, led by taxable municipal (–11.8%), municipal high yield (–12.0%) and national municipal funds (–8.9%). Some of the more equity-like fixed income types, such as convertibles (–7.3%) and preferred securities (– 6.5%), also struggled in the quarter. Among equity funds, MLP funds (2.4%) stood out, rising amid high energy prices and healthy pipeline throughout levels.
Discounts to net asset value diverged in the selling pressure. Taxable fixed income discounts to NAV expanded to 6.6%, leaving them wide of their long-term average of 3.3%. Municipal fund discounts also widened, settling at 7.6%, compared with a long-term average of around 4.0%. Surprisingly, equity fund discounts narrowed in the quarter, perhaps due to companies’ ability to raise prices (and dividends) in an inflationary environment.
We remain relatively cautious given the slowing economy, elevated inflation and the potential for high inflation to persist. We expect markets will remain volatile in the near term as the Fed keeps a close eye on key inflation metrics. Should the Fed continue to tighten in an aggressive manner, discounts to NAV could continue to expand, retreating from the historically full valuation levels reached in 2021. Rising rates also impact the earnings power of closed-end funds with a flatter yield curve a headwind for dividends.
The primary market for closed-end funds remains closed – at least for now. Desire for new closed-end offerings continues to be low as investor sentiment favors more seasoned issues. We will continue to seek opportunities created by market volatility as well as through value dispersions between more and less seasoned CEF’s in the secondary market.
(1) Returns are based on market price. Prior to 7/31/19, the benchmark was the Morningstar US All Taxable Ex-Foreign Equity Index. Thereafter, it is the S-Network All Taxable ex-Foreign plus Capped Muni CEF Index. The S-Network All Taxable ex-Foreign plus Capped Muni CEF Index is a market capitalization-weighted index comprising all taxable closed-end funds and Diversified Municipal Bond Funds, except for single-country funds and region-specific equity funds. The Morningstar US All Taxable Ex-Foreign Equity Index measures the market-capitalization-weighted total return of taxable equity and fixed income closed-end funds; it excludes international, regional and country closed-end funds. Index returns update frequently and are subject to change. All closed-end fund sector returns are based on Cohen & Steers calculations and classifications of the current U.S. listed closed end fund universe.
(2) The S&P 500 Index is an unmanaged index of 500 large capitalization, publicly traded stocks that is frequently used as a general measure of stock market performance.
(3) The Barclays Capital U.S. Aggregate Bond Index includes U.S. government, corporate and mortgage-backed securities with maturities of at least one year. Benchmark returns are shown for comparative purposes only and may not necessarily be representative of the Fund's portfolio.
Data quoted represents past performance, which is no guarantee of future results.
The S-Network All Taxable ex-Foreign plus Capped Muni CEF Index is a market capitalization-weighted index comprising all taxable closed-end funds and Diversified Municipal Bond Funds, except for single-country funds and region-specific equity funds. The index reconstitutes and rebalances quarterly.
Index Source: S-Network Closed End Fund Indexes are calculated, distributed and marketed by S-Network Global Indexes Inc. which have been licensed for use. All content of the S-Network Closed End Fund Indexes 2022 are the intellectual property of S-Network Global Indexes Inc.
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