Closed-end fund commentary 4Q 2024

Closed-end fund commentary 4Q 2024

5 minute read

January 2025

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Closed-end funds had a market-price return of 18.26% for the year, as measured by the S-Network All Taxable ex-Foreign plus Capped Muni CEF Index1. By comparison, the S&P 500 Index2 and the Bloomberg U.S. Aggregate Bond Index3 had total returns of 25.02% and 1.25%, respectively

Closed-end funds moved higher across the board in 2024, posting double-digit returns in what was a strong year for capital markets generally. Economic growth exceeded expectations throughout the year, and inflation trended lower in the first half before stabilizing in the 2.5% to 3% range. The Federal Reserve reduced its benchmark lending rate three times in the second half, but healthy economic growth and stubborn inflation sharply reduced investor expectations for additional rate cuts in 2025. In this environment, U.S. equity returns exceed 20% for a second consecutive year. Bond yields were fairly volatile, with the 10-year U.S. Treasury rising from around 3.9% to settle close to 4.6%, near its highs for the year. Narrowing credit spreads supported fixed income investments, however.

Valuations on closed-end increased across the board. Discounts to net asset value (NAV) for the three major fund categories—equity, taxable fixed income, and tax-free municipal bonds—narrowed in the year. In addition to the gains in underlying asset values, the closed-end fund market was supported by a lack of new issuance. As well, distribution increases, tender offers and investor activism to shutter or merge existing funds increased the appeal of the remaining funds.

Equity funds rose meaningfully with the strong performance of broad-based stock indices. MLP funds led the gains, benefiting from improving underlying midstream energy fundamentals. Funds with broader mandates also produced healthy returns for the year, including U.S. general equity, U.S. and global hybrid funds and option income funds. Real estate and other sector-specific equity funds had more modest returns. Overall, equity funds saw average discounts narrow from –8.6% at the start of the year to –4.6%, which is tighter than its long-term average.

The taxable fixed income group gained as a significant narrowing of credit spreads positively impacted credit- sensitive sectors. Convertible bond funds led the category due to a conducive movement in equity markets and significant contractions in discounts to NAV. Preferred securities, which are among the most interest rate sensitive within taxable fixed income, also performed well. Taxable municipal bond and U.S. government bond funds lagged amid policy uncertainty and higher interest rates, which weighed on the underlying bond prices. Overall, the average price to NAV for taxable fixed income funds moved from a discount to a modest premium.

Tax-free municipal bond funds, which are primarily composed of long-duration, investment-grade bonds, ended the year with modestly positive returns on an NAV basis. Overall, the group had stronger returns on a market price basis as the average discount to NAV narrowed from –13.0% at the beginning of the year to –8.8%. High-yield municipal funds led the category. National municipal bond funds had more modest, though still healthy, returns due to their longer duration and higher interest rate sensitivity, while seeing discounts to NAV also narrow. Tax-free municipals are one category where discounts to NAV remain well wide of their historical average.

The backdrop for equity and fixed-income investments (and for closed-ends) remains constructive. While global growth has softened, the U.S. stands out as a relatively strong economy. Monetary policy is also supportive of asset values. The extent of the monetary policy easing will depend on growth and labor market trends. The current labor market data does not suggest a need for aggressive interest rate cuts by the Federal Reserve. If interest rates remain elevated for a longer period of time, then downside risks to the economy will increase. (So far, the risks have been mitigated by economic health and the resilient state of consumer balance sheets.) While the election outcome has reduced uncertainty in the markets, policy specifics from the new administration remain a key factor to consider. We remain vigilant for market opportunities that may emerge from these economic dynamics.

The primary market for closed-end fund IPOs remains closed and will likely stay quiet until positive performance and more confidence in the future path of interest rates take hold.

However, tighter valuations within the taxable fixed income space have put opportunities for incremental capital raises more into focus.