Are Closed End Funds Right For Your Portfolio_1

Post on: 16 Март, 2015 No Comment

Michael Fabian: Balancing the sentiment of last weeks article about the pitfalls of closed end fund investing ; its tough to get enthusiastic when so many dangers exist with these seemingly complex investment vehicles. Which is why I believe its important for investors to understand if they are indeed well suited for CEFs in the first place. We continue to have conversations with prospective clients that are interested in CEFs but are timid about the prospects for added volatility, lack of correlation, tax ramifications, and premiums/discounts.

One of my personal investing tenets is to never get involved with an investment I dont understand. So my hope is to sluice down all of the intricacies of CEFs to just the areas that deserve the most attention, and thereby remove any intimidating factors that may exist in your investor psyche.

Due Diligence

Most investors approach the evaluation of an ETF or mutual fund in the same way. Beginning by analyzing past performance, top holdings, fees, Morningstar ratings, fund size, etc. That seems to give them enough confidence to pull the trigger. After all, they can always liquidate at NAV any time right?

While there are a lot of similarities in that process that I agree with, analyzing CEFs require a slightly different tact. My recommendation is to start by (1) evaluating at a funds strategy and management team, (2) then underlying NAV performance, and finally (3) premium or discount history.

If the ducks arent lining up at this point, just move along to other opportunities. Conversely, if a fund does pass that initial smell test, then it essentially gives you a feel for where the fund is trading relative to its peer group and historical norms.

Once you have a sense of value and an investment thesis built for the underlying asset class, continue on to less important factors such as fund size, leverage ratio, and management fees. I also tend to discount Morningstars rating or opinion of a fund. In the past, there have been many funds that Morningstar has chastised, and yet they were trading at excellent relative valuations for attractive investment opportunities. With CEFs its always better to form your own research and opinions, that way you have a plan to fall back on when the going gets tough.

Keep in mind that there are other important data points that can be a big deciding factor to the success of a fund, such as underlying earnings and distribution polices . However, for the sake of getting started, I recommend beginning with the basics and then graduate to examining semiannual and annual reports to confirm your analysis.

Funds that are out of whack from a corporate actions or management perspective typically dont garner much investor attention, so you shouldnt get caught up in a bad investment if you stay with fund sponsors that you can trust. From my experience trustworthy sponsors include PIMCO, DoubleLine, Blackrock, Gabelli, Nuveen, Western Asset, and Eaton Vance to name a few.

Bookmark the website CEFconnect.com; it will be one of your best sources for closed-end fund market data. Just be sure to confirm the data with the actual fund sponsors website, as occasional discrepancies and stale data are an issue.

Ive long held the belief that the general population would choose to perform more due diligence on a flat screen TV purchase than they would choosing the investments that make up their life savings. It could stem from a lack of interest, but its more likely just a lack of proper planning.

I believe that focused due diligence in these key areas will allow any investor to be successful with closed end funds. Just keep in mind that due-diligence is a required prerequisite to investing in CEFs, if youre not interested in putting in the time, they are not right for your portfolio.

Develop a Plan

Most investors think that having a plan is akin to choosing an asset allocation and then building a portfolio that coincides with that goal. After all, typical portfolio management methodologies mandate that you try to avoid making an abundance of changes and choose highly diversified, low cost investment vehicles.