Closed-end funds had a market-price return of 16.6% in the quarter, as measured by a linked benchmark consisting of the Morningstar U.S. All Taxable ex-Foreign Equity Closed- End Fund Index and the S-Network All Taxable ex-Foreign plus Capped Muni CEF Index.1 By comparison, the S&P 500 Index2and the Barclays Capital U.S. Aggregate Bond Index3 had total returns of 20.5% and 2.90%, respectively.
Closed-end funds had broadly positive returns in the second quarter reflecting an improved economic outlook and the use of unprecedented fiscal and monetary policies to combat the economic impact from COVID-19. Equity and credit-sensitive fixed income sectors, which declined sharply during the first quarter on containment efforts, rebounded as worldwide stay- at-home requirements were relaxed and supportive monetary and fiscal policies were introduced. These included the Federal Reserve buying corporate bonds for the first time, providing liquidity to the market and helping to remove tail-risk for investors.
Equity funds led the way among major categories, consistent with the record-setting equity rally in the quarter. The group advanced 20.9% on a market price basis, led by MLP funds (48.4%) which, in addition to supportive equity sentiment, responded positively to the improvement in the longer-term crude oil supply/demand landscape.
Taxable fixed income funds (15.7%) were led by the more equity-sensitive sectors, including convertible bonds (27.3%), and high yield bonds (16.0%). Preferred funds also performed well (19.0%) At the other end of the performance spectrum was the U.S. sector bond funds category (9.3%), which invests primarily in mortgage-backed securities. The performance of short duration fixed income funds (11.0%) also lagged with short-term interest rates near zero and the Federal Reserve indicating that it will not raise rates again soon.
Closed-end fund discounts to net asset value (NAV) narrowed across nearly all categories in the second quarter. The average discount to NAV in the taxable fixed income category compressed from 5.7% to 4.7%, compared with a long-term average of 3.3%. National municipal funds saw their average discount narrow to 7.3% from 7.5%, compared to their long- term average of 3.9%. Discounts for equity funds also narrowed, to 6.2%, wide of the category's long-term average discount of 5.2%.
Despite continuing uncertainties surrounding the full scope of the economic impact of the coronavirus pandemic, assuming containment efforts are largely successful and central banks and governments sustain their commitments to accommodative monetary and fiscal policies, we expect that economic growth will resume in most developed countries in the second half of the year.
Our outlook for closed-end funds remains generally positive. Each of the three major closed-end fund groups—Taxable fixed Income, Equity and Municipal—feature valuations cheap to their long term discount averages. While valuations and fund prices and NAV's may be volatile in response to Covid- 19 news flow, we believe that the record Federal Reserve and fiscal response to the crisis creates and environment where fund valuations and underlying asset class valuations will improve over time.
Lower short-term interest rates should help the earnings power of levered closed-end funds. We think the Federal Reserve's position on keeping interest rates extremely low should continue to raise the appeal of these relatively higher- yielding structures. Assuming the economy stays on a path to recovery, trends still favor closed-end funds in investors' hunt for income. That demand should help closed-end fund valuations across the board to narrow further.
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(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.