CLOSED-END FUND

RESEARCH AND PORTFOLIO MANAGEMENT

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Researching mutual funds has been the "wheelhouse" of our firm since the beginning. In the early 2000's, we started researching Closed-End Funds in what seemed like a natural progression for our research capabilities. The research we uncovered was compelling, and inevitably led to the formulation of a proprietary investment strategy, and discretionary portfolio management. Today we are one of only a handful of firms across the United States who specialize in managing portfolios of discounted Closed-End Funds for our clients.

WHAT ARE CLOSED-END FUNDS?

Closed-End Funds (CEFs) are mutual funds that trade on an exchange, similar to a stock. They are regulated by the Investment Company Act of 1940, similar to Traditional Open-End Mutual Funds and Exchange Traded Funds. However, there are a number of key differences that make CEFs unique:

 

CEF MARKET INEFFICIENCY

The CEF market is inefficient. Generally speaking, proponents of an efficient market believe that all publicly available information about an asset is reflected in the asset's price. In contrast, an inefficient market is one where all publicly available information about an asset is not necessarily reflected in the asset's price, suggesting bargains are available.

WHY THE CEF MARKET IS INEFFICIENT:
CEFs often trade at a price that is below (discount)
or above (premium) their Net Asset Value (NAV)
There are hundreds of CEFs in many asset classes, but relatively few covering analysts, limiting information and efficiency
Historical data on CEFs is limited and often incomplete
 
Overall investor breakdown in
the CEF Market is approximately
80% Retail / 20% Institutional:
RETAIL
INSTITUTIONAL
RETAIL INVESTORS DOMINATE MARKET
Incredibly important to point out, as retail investors (as a whole) typically make investment decisions driven by emotion
Research indicates retail investors often chase performance: Purchase a fund after recent great performance; and
Sell a fund after what is perceived as poor performance
"Emotional" fund flows often move a CEF's price more so than its underlying NAV, which creates trading opportunities
See: Profit by Trading Against the Average Investor
THE CONNECTION BETWEEN CURRENT DISCOUNTS AND FUTURE RETURNS

Based on the success of various accounts we managed during 2000-2005 that focused on discounted CEFs, we began managing a partnership to capitalize on what appeared to be a steady relationship between large discounts and high subsequent total returns. The results were almost entirely satisfactory.

 

In 2008, we decided to investigate whether this relationship had historically persisted over time. Surprisingly, we found no evidence that anyone had ever engaged in such an investigation before. The only CEF index we found, in fact, was a 30-fund index calculated by Herzfeld Advisors in Miami, and provided weekly in Barron’s.

Academic studies were scarce, and we found none dedicated to answering the simple question:


Do large discounts lead consistently to higher total returns?


So in conjunction with the Cameron Center for Finance and Securities Analysis (Lundquist College of Business; University of Oregon), we set about constructing our own indexes of CEFs. We quickly found that nearly all the databases with information about CEFs threw out the data when funds went out of existence (either through liquidation, merger, or conversion into an open-end fund). And so we decided to do the best we could by taking all 600+ CEFs in existence in 2008, and collecting all relevant data on these funds back as far as we could.

STUDY RESULTS SUMMARY

Historically, for U.S. CEFs, discounts to NAV have been highly correlated with subsequent total returns.

Results are statistically significant across time, and across different CEF types.

A simple investment strategy based on discounts demonstrates impressive long-term results:

  • 20% Annualized Return

  • 0.7 Beta to the S&P 500

  • 13% Annualized Alpha to the S&P 500

PROPRIETARY

ACADEMIC RESEARCH

SPONSORED BY:
 
 

MATISSE PRIVATE RESEARCH DATABASE

The University of Oregon study laid the foundation for what (to our knowledge) is now the longest known proprietary research database on CEF discounts
30+
YEARS OF RESEARCH
360+
MONTHS OF DATA
500+
CLOSED-END FUNDS
1,000,000+
DATA POINTS
 

CEF MARKET STATISTICS

(as of 3.31.2020)

Total Size in AUM

Approx. $195 Billion

Number of Funds

486

Number of Fixed Income Funds

290

Number of Equity Funds

113

Number of Balanced/Other Funds

83

Number of CEF Categories

67 (separate Morningstar® categories represented)

Percentage Trading at a Discount

88%

Percentage Trading at a Premium

12%

Distribution of CEF Total Market Cap Across Asset Classes (as of 3.31.2020)

CEF Categories

Weight by Fund Count

Weight by Market Cap

Municipal Bonds

30%

28%

Taxable Bonds

30%

29%

Sector Equity

13%

14%

International Equity

6%

3%

US Equity

4%

6%

Balanced

10%

8%

Alternative/Commodity/Other

7%

13%

Distribution of Highly Discounted CEFs (as of 3.31.2020)

Defined as CEFs falling in the widest quintile of discounts

Municipal Bonds

5%

3%

Taxable Bonds

24%

34%

Sector Equity

28%

20%

International Equity

19%

11%

US Equity

8%

16%

Balanced

8%

7%

Alternative/Commodity/Other

8%

8%

Source: Matisse Capital

 

MATISSE INVESTMENT PROCESS

Primary

Quantitative

Screen

Discount and Yield Screening

Secondary

Quantitative

Screens

Absolute Discount to NAV

Distribution Yield

Discount Volatility

Historical NAV Relationship

Management Quality

Dividend Security

Fund Expense

Underlying Portfolio

Fund Size and Liquidity

Major Owners of Security

Insider Buying

Portfolio Construction

Shareholder Activism

Tax-Loss Selling Elimination

Ongoing

Qualitative

Analysis

Contrarian Asset Allocation

Exposure: Typical Position Size 1% to 5%

45 - 60 Core Holdings

Trade

Execution

Our academic research indicates that proper sizing of positions can enhance performance and returns

 

INVESTMENT PROCESS APPLICATION

Understanding CEF Returns

Market price increases relative to its NAV

NAV
Return

The change in value of a CEF's underlying assets (Net Asset Value)

+

Income
from CEF

Any dividends paid out by the CEF

-

Fees/ Expenses
Discount
Widening

Market price decreases relative to its NAV

Discount
Narrowing

-

+

=

or

Total
Return

Source: Matisse Capital

This graphic is a basic representation of Closed-End Fund returns and should be used for illustrative purposes only. There are other factors that can increase or decrease the total return of a Closed-End Fund.

 

MANAGED ACCOUNT PERFORMANCE

PORTFOLIO MANAGERS
Bryn Torkelson
President, CIO
Eric Boughton, CFA
Portfolio Manager, Chief Analyst
INVESTMENT OBJECTIVE: GROWTH & INCOME
The Strategy's investment objective is to produce superior risk-adjusted returns by purchasing income-producing CEFs at significant and unwarranted discounts to NAV. We scrutinize the entire universe of US CEFs daily, using our proprietary statistical model to select CEFs best positioned for both capital gains and income. We build a diversified, globally balanced portfolio using CEFs.

The Strategy's Indicated Annualized Cash Distribution Yield is 6.3% - Sharpe Ratio since inception is 0.44

Since Inception 1.1.2006

Performance Analysis 7.31.2020

Total

Annualized

10-Year

5-Year

3-Year

1-Year

Beta

Alpha

R2

Matisse Discounted CEF Strategy

S&P 500 Total Return

S-Network Composite CEF Index

MSCI ACWI

S&P Target Risk Growth Index*

165.1%

255.4%

135.5%

140.9%

130.2%

6.9%

9.1%

6.0%

6.2%

5.9%

6.3%

13.8%

6.5%

8.9%

7.8%

4.1%

11.5%

6.4%

7.4%

6.3%

-1.5%

12.0%

2.7%

7.0%

6.1%

-14.2%

12.0%

-1.9%

7.2%

7.5%

0.84

1.03

0.80

1.28

-0.29%

0.87%

2.08%

-0.05%

0.66

0.87

0.70

0.71

Our since-inception risk stats vs. these indexes

*A multi-asset class globally balanced index with fixed allocation of 60% equity, 40% bonds

Returns are presented after a presumed 1% annual fee. All returns longer than 1 year are annualized unless noted.

Risk vs. Return

ANNUALIZED

RETURN

10%

9%

8%

7%

6%

5%

S&P 500 Total Return

S&P Target Risk Growth Index

Matisse Discounted CEF Strategy

S-Network Composite CEF Index

MSCI ACWI

9%         10%         11%         12%         13%         14%         15%         16%         17%

ANNUALIZED STANDARD DEVIATION

Matisse Discounted CEF Strategy Monthly Performance (%) after a presumed 1% annual management fee

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Year

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

-1.40%

10.16%

3.33%

3.66%

-6.08%

0.50%

-1.50%

5.54%

6.68%

-0.03%

0.38%

3.52%

0.28%

-0.25%

3.18%

-9.52%

2.83%

-3.49%

2.72%

1.08%

2.56%

5.55%

-0.55%

3.39%

1.97%

2.29%

-9.90%

-1.26%

0.63%

1.63%

-27.70%

1.77%

-1.17%

1.45%

9.35%

0.04%

0.24%

1.70%

0.81%

0.56%

3.77%

4.65%

-2.63%

1.24%

0.23%

11.52%

1.17%

0.14%

2.18%

3.16%

1.06%

2.21%

0.83%

-0.49%

2.04%

2.46%

9.17%

4.91%

2.78%

-0.96%

5.40%

-4.21%

-0.54%

0.99%

0.35%

-0.48%

3.19%

-1.27%

-5.80%

0.76%

-6.50%

9.49%

3.56%

1.33%

-0.80%

2.04%

4.27%

-0.44%

1.38%

2.06%

-3.83%

2.25%

-3.12%

3.68%

-0.26%

-1.50%

3.87%

-4.90%

-1.61%

2.11%

3.25%

0.60%

1.47%

2.46%

4.40%

-1.62%

-1.39%

0.17%

2.24%

-2.00%

6.12%

7.62%

-3.30%

-2.91%

3.32%

 

-1.25%

0.11%

0.27%

1.00%

-5.95%

1.58%

-2.12%

1.78%

-3.91%

-0.28%

3.82%

-0.98%

0.04%

4.05%

 

3.05%

-1.13%

1.16%

0.17%

-2.95%

-3.63%

3.04%

2.70%

-6.63%

8.13%

6.19%

-14.93%

2.69%

1.87%

 

-0.89%

-5.56%

0.82%

-3.13%

7.34%

0.27%

2.23%

-0.12%

5.95%

3.00%

-1.84%

-8.90%

1.20%

3.36%

 

1.20%

2.38%

0.42%

1.28%

-2.12%

0.75%

-1.18%

-1.03%

-1.15%

0.49%

3.87%

-15.03%

-1.96%

2.04%

 

5.17%

-4.21%

1.81%

2.09%

-0.73%

-0.06%

2.50%

1.52%

0.43%

3.46%

3.55%

9.09%

1.23%

2.24%

-20.11%

25.80%

-9.10%

21.08%

16.03%

-6.61%

9.56%

7.68%

15.90%

-2.81%

23.19%

51.78%

-31.48%

4.33%

24.51%

Performance cited represents a composite of all Matisse Capital-advised accounts employing our discounted closed-end fund strategy, including our publicly traded mutual fund, net of all commissions, and separate accounts with a presumed 1% management fee. Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur. For details of the performance calculation method, please download our separate audited report. All performance figures for the strategy (except cash distribution yield) are total returns net of actual commissions incurred, and net of a presumed 1% annual management fee. Benchmark returns, by contrast, do not reflect a deduction for fees. You cannot invest directly in an index. Performance comparisons are for illustrative purposes only and are not a forecast of future returns. Alpha, beta and R2 are annualized since inception.

 

The benchmarks referenced are included to reflect the general trend of the markets during the periods indicated and are not intended to imply that the underlying returns were comparable to the market indices either in composition or element of risk. There are significant differences between client accounts and the indices herein including, but not limited to, risk profile, liquidity, volatility, and asset composition. The S&P 500 Index is a capitalization-weighted index comprised of 500 stocks chosen for market size, liquidity and broad industry group representation within the U.S. economy. Index returns represent gross returns, and are provided to represent the investment environment during the time periods shown and are not covered by the report of the independent verifiers.

Closed-end funds involve investment risks different from those associated with other investment companies. First, the shares of closed-end funds frequently trade at a premium or discount relative to their net asset value. When one purchases shares of a closed-end fund at a discount to its net asset value, there can be no assurance that the discount will decrease, and it is possible that the discount may increase and affect whether one will realize a gain or loss on the investment. Second, many closed-end funds use leverage, or borrowed money, to try to increase returns. Leverage is a speculative technique and its use by a closed-end fund entails greater risk and leads to a more volatile share price. If a closed-end fund uses leverage, increases and decreases in the value of its share price will be magnified. The closed-end fund will also have to pay interest or dividends on its leverage, reducing the closed-end fund’s return. Third, many closed-end funds have a policy of distributing a fixed percentage of net assets regardless of the fund’s actual interest income and capital gains. Consequently, distributions by a closed-end fund may include a return of capital, which would reduce the fund’s net asset value and its earnings capacity. Finally, closed-end funds are allowed to invest in a greater amount of illiquid securities than open-end mutual funds. Investments in illiquid securities pose risks related to uncertainty in valuations, volatile market prices, and limitations on resale that may have an adverse effect on the ability of the fund to dispose of the securities promptly or at reasonable prices.

 

AUDITED CEF STRATEGY PERFORMANCE

Performance cited represents a composite of all Matisse Capital-advised accounts employing our discounted closed-end fund strategy, including our publicly traded mutual fund, net of all commissions, and separate accounts with a presumed 1% management fee. Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur. For details of the performance calculation method, please download our separate audited report. All performance figures for the strategy (except cash distribution yield) are total returns net of actual commissions incurred, and net of a presumed 1% annual management fee. Benchmark returns, by contrast, do not reflect a deduction for fees. You cannot invest directly in an index. Performance comparisons are for illustrative purposes only and are not a forecast of future returns. Alpha, beta and R2 are annualized since inception.

Closed-end funds involve investment risks different from those associated with other investment companies. First, the shares of closed-end funds frequently trade at a premium or discount relative to their net asset value. When one purchases shares of a closed-end fund at a discount to its net asset value, there can be no assurance that the discount will decrease, and it is possible that the discount may increase and affect whether one will realize a gain or loss on the investment. Second, many closed-end funds use leverage, or borrowed money, to try to increase returns. Leverage is a speculative technique and its use by a closed-end fund entails greater risk and leads to a more volatile share price. If a closed-end fund uses leverage, increases and decreases in the value of its share price will be magnified. The closed-end fund will also have to pay interest or dividends on its leverage, reducing the closed-end fund’s return. Third, many closed-end funds have a policy of distributing a fixed percentage of net assets regardless of the fund’s actual interest income and capital gains. Consequently, distributions by a closed-end fund may include a return of capital, which would reduce the fund’s net asset value and its earnings capacity. Finally, closed-end funds are allowed to invest in a greater amount of illiquid securities than open-end mutual funds. Investments in illiquid securities pose risks related to uncertainty in valuations, volatile market prices, and limitations on resale that may have an adverse effect on the ability of the fund to dispose of the securities promptly or at reasonable prices.

 
 

EDUCATION CENTER

The Education Center is a collection of external research and articles that we have found to be important, interesting, or helpful in understanding closed-end funds.

Links

Matisse Capital is not affiliated or endorsed by Closed-End Fund Association, Inc., Nuveen Investments, Inc., or Social Science Electronic Publishing, Inc. Matisse Capital is not responsible for the content of external websites. The content contained in the above links is not the property of Matisse Capital.

 

The website is controlled and operated by Deschutes Portfolio Strategy, LLC dba Matisse Capital from its offices within the State of Oregon, United States of America. Matisse Capital makes no representation that materials on the site are appropriate or available for use in other locations, and access to them from territories where their content is illegal is prohibited. The information provided on this website is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject Matisse Capital or its affiliates to any registration requirement within such jurisdiction. Shares in the Matisse Discounted Closed-End Fund Strategy mutual fund are offered by prospectus only.

 

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