June 2023 IssueLong scroll reading

Taylor the Investor: You belong with me!

By David Snowball

Taylor Swift might be the swiftest young investor of her generation. Ms. Swift, 33, saw her net worth creep up over the past year, from $570 million at the beginning of 2022 to $740 million now. Most of that wealth is driven by the feverish desire of her fans, the 120,000,000 or so Swifties, to transfer their money to her. At the same time, she’s done prudent and profitable things with her wealth. Other young investors can learn from her reasoning and parallel her strategy.

(Well, give or take the “multi-platinum pop superstar” part of the strategy.)

America is beset by an appalling number of appallingly rich people. In 2023, for instance, Forbes magazine estimates that America leads the world with 735 billionaires worth a collective $4.7 trillion. (More than China and India combined. Take that, crazy rich Asians!) Many of them, and many of Ms. Swift’s peers, are classified as “high-beta rich.” They are rags to riches to rags people, often driven by delusions of their own brilliance or by the unexamined promises of vast wealth offered by others.

Ms. Swift, the child of a Merrill Lynch broker, seemed to have learned early on that “too good to be true” probably means “it’s a scam.” The most famous instance involves her refusal to partner with the (now disastrously) bankrupt cyber exchange FTX to sell NFTs to the Swifties. (Tickets for her June 2023 shows in Chicago were selling for as much as $5400 on the secondary market, so you know they would have bought them.) Reportedly, she asked one question that ended the discussion:

“Can you tell me that these are not unregistered securities?”

Oops. Game over, wealth preserved. (Cheyenne DeVon, CNBC, “Taylor Swift sidestepped FTX lawsuit,” 4/20/23)

Instead, Ms. Swift’s portfolio holds a lot of real estate, perhaps $150 million worth, and a slug of … discounted closed-end funds?

Yep. The news came from two sources with an interest in the matter: Boaz Weinstein, head of Saba Capital Management which invests in the same funds, and Scott Swift, Taylor’s dad, and a former Merrill Lynch vice president. (Hmmm, mom Andrea Swift used to be in fund marketing.) Here’s the tweet:

“Having a blast watching our daughter sing every lyric tonight in Philly. Did you know that @taylorswift13 invests in discounted closed end funds? You think I’m kidding, but her father, Scott, told me so!”

We’ll answer two questions:

  1. What on earth is a closed-end fund?
  2. How can I get them?

The closed-end fund primer

Closed-end funds are pooled investment vehicles, much like mutual funds (which are technically “open-end funds”) and exchange traded funds.

They differ from mutual funds in two important ways. First, they trade on the secondary market throughout the day, just like stocks or ETFs do. Because of that, each CEF publishes two share prices: the net asset value is what their holdings are worth, and the market price is what investors are willing to pay, this minute, for them.

Let’s say your fund, MFO Securities Trust, issued a million shares, and by happy coincidence, the total value of the securities it owns is $10 million right now. Every share would then have a net-asset value of $10.

But what if you’re feeling panicked and very much want to sell? Right! Now! How much cold hard cash would it take to get you to surrender your share? $10 is “right,” but markets are about psychology. You’d probably say “no” to a $5 offer, but you’d entertain a $8.50 offer and would snap up $9.00. If you sold at $9.00, the market price is $9.00, and the fund traded at a 10% discount to NAV.

Second, closed-end funds can use leverage to boost returns. CEFs can borrow money, using their portfolio as collateral, to buy extra shares of securities. By law, they can exercise leverage of between 1.3 – 1.5 times assets; that is, a $10 million fund can own up to $15 million worth of stuff. About two-thirds of CEFs use such tactics (Investment Company Institute, 4/2023).

They differ from ETFs in two important ways as well. First, the number of fund shares never changes. ETFs can issue more shares through “creation units” as time goes on, which allows them to stabilize demand for their products. Otherwise, there could be a bidding war for shares of a particularly attractive ETF, leading it to sell at a premium to its NAV; that is, people might pay $15 for a $10 share of the ETF just as they might pay $1200 – 5400 for a $300 Taylor Swift ticket. Second, closed-end funds can invest in illiquid securities to a far greater extent than ETFs or funds can. An illiquid security is something that you can’t reasonably expect to sell in a hurry; if, for example, you buy an apartment building, it might be a great investment, but it’s not one you can get rid of at a moment’s notice. Selling it is probably all-or-nothing (you can’t sell just the third floor), and it might take six months to find the right buyer. Funds and ETFs can hold only a tiny slice of their portfolios in such juicy opportunities; CEFs can go all-in (Baird & Co., 2021).

Upside: CEFs can get you access to investment opportunities that no one else can touch, and they can generate incredibly high yields by using leverage. The total distribution rate is a surrogate for the fund’s income yield; it includes all of the money returned to shareholders in a year, largely interest and dividends but occasionally return-of-capital.

  Total Distribution Rate
OFS Credit Company Inc 22.9%
Eagle Point Credit Company 19.0
Cornerstone Total Return Fund 18.6
Cornerstone Strategic Value Fund 18.6
Virtus Stone Harbor Emerging Markets Total Income Fund 18.5
Abrdn Income Credit Strategies Fund 18.0
Virtus Stone Harbor Emerging Markets Income Fund 18.0
Oxford Lane Capital Corporation 17.8
NXG Cushing Midstream Energy Fund 16.1
Abrdn Global Income Fund Inc. 15.9
Virtus Total Return Fund Inc. 15.9
XAI Octagon Floating Rate & Alternative Income Term Trust 15.7
RiverNorth/DoubleLine Strategic Opportunity Fund 15.0
Korea Fund 14.9
The Gabelli Multimedia Trust 14.7
Brookfield Real Assets Income Fund 14.7
Pimco Dynamic Income Fund 14.5
Neuberger Berman High Yield Strategies 14.4
John Hancock Tax Advantage Global Shareholder Yield Fund 14.3
Eagle Point Income Co 14.2
Guggenheim Strategic Opportunities Fund 13.9
CBRE Global Real Estate Income Fund 13.9
RiverNorth Opportunities 13.9
Principal Real Estate Income Fund 13.5
Clough Global Dividend And Income Fund 13.5
Saba Capital Income & Opportunities Fund 13.4

Downside: CEFs are involved in expensive operations and can be exceptionally volatile. That scares investors, and so CEF shares typically sell at a discount to their NAV. That is, you can routinely buy $10 worth of securities for $8.50! Which is great as long as someone else is willing to pay you more than $8.50 for that same share.

Here’s the special sauce: there are two reasons why people would pay you more than $8.50. Reason 1: the underlying stocks rose in value. Reason 2: the stocks did not rise in value, but panic passed, and investors were willing to pay something close to $10 for $10 worth of stock. If the market rises, you make money (just as in funds and ETFs), or if people just calm down, you make money (unlike in funds and ETFs). So discounted CEFs offer three drivers of return: the use of leverage, normal capital appreciation, and shrinking share-price discounts.

Investing in closed-end funds

The oldest of the CEFs dates back to the Great Depression. Some have been stellar performers for decades. Many offer access to distinctive and interesting asset classes. You have two options for purchasing them.

Option 1: buy CEFs, one by one, at any major brokerage.

Option 2: buy a mutual fund or ETF of CEFs run by discounted CEF specialists.

MFO Premium users can easily screen for exceptional CEFs and compare them side-by-side with open-end funds and ETFs. (Morningstar users, not so much. Sorry, guys.)

Closed-end funds with the highest 20-year Sharpe ratios

  Lipper Category APR MAX Drawdown Sharpe Ratio Great Owl? ER Assets
Barings Participation Investors General Bond 10.8 -10.8 1.23 Yes 2.09 159
Barings Corporate Investors General Bond 10.9 -21.8 0.97 No 2.09 332
TCW Strategic Income Income & Preferred Stock 7.7 -28.6 0.75 No 1.02 243
Allianz PIMCO Corporate & Income Opportunity General Bond 11.6 -46.9 0.68 No 1.13 1,514
MFS Charter Income Trust General Bond 5.4 -17.1 0.67 No 1.37 300
Rocky SRH Total Return Inc Diversified Equity 9.9 -33.2 0.67 No 1.61 1,542
Central Securities Corporation Diversified Equity 10.3 -45.7 0.66 No 0.50 1,178
MFS Multimarket Income Trust General Bond 5.9 -18.1 0.65 No 1.40 292
AllianceBernstein Global High Income High Yield (Leveraged) 8 -30.7 0.64 No 1.00 915
Allianz PIMCO Strategic Income Global Income 6.9 -24.5 0.63 No 1.44 199
Vanguard Total Stock Index Core Stock 10.1 -50.9 0.58 No 0.14 1.25 trillion
Vanguard Total Bond Index Core Bond 3.0 -17.6 0.44 No 0.15 300 billion

Source: MFO Premium fund screener / Lipper Global Datafeed, through 04/2023. We’ve included Vanguard’s Total Stock and Total Bond Market Index funds for comparison. In Sharpe ratio terms, Total Stock did fine, and Total Bond lagged the CEF universe.

But remember: six out of seven CEFs sell at a discount to NAV. Top-rated Barings Participation sells at a 15% discount, and #2 Barings Corporate sells at a 16.58% discount. Central Securities trades at a 15.22% discount (per Fidelity CEF screener, 6/2023). The key is finding one whose discount is temporary. That’s where Option 2: Funds of CEFs comes in.

Several firms offer funds whose portfolios are made up of discounted CEFs. In theory, each fund has a target allocation (“50% domestic equities, 10% international equities, 40% fixed income”), and they identify the CEFs in that space that are suffering from temporary large discounts to NAV. Ideally, they find a fund that normally sells at a 10% discount but which this week can be purchased for a 20% discount. With luck, the discount will shrink back to 10%, and investors will pocket a handy, market-neutral gain.

Three funds – two open-ended and one ETF – offer experienced teams and balanced CEF portfolios. Because the youngest of those funds, Saba, just launched in 2017, we’re providing just a five-year profile.

Five-year performance

  APR STDEV DS DEV MAX DD Sharpe Ratio Ulcer Index 60/40 Up Cap 60/40 Down Cap 60/40 Capture ER Assets
Saba Closed-End Funds ETF 7.2 17.1 12.5 -25.2 0.33 6.4 102 105 0.97 2.42 102
Vanguard STAR 6.3 13.7 9.4 -23.8 0.35 8.3 101 109 0.92 0.31 22 billion
Matisse Discounted Closed-End Strategy 5.6 21.1 16.2 -37.1 0.19 10.3 115 136 0.85 2.48 37.1
RiverNorth Core Opportunity 4.7 15.9 11.9 -25.5 0.20 8 96 113 0.85 3.56 45.4

Source: MFO Premium fund screener / Lipper Global Datafeed, through 04/2023. We’ve included Vanguard STAR, a balanced fund of actively managed Vanguard funds, as a benchmark.

Measured by five-year performance, Saba Closed-End Funds ETF has offered higher returns (APR) and higher risk-adjusted returns (Ulcer Index, 60/40 capture ratio) than its peers. Its diversified, actively managed, and hedges its interest rate risk.

RiverNorth is the Grand Old Man of the group, offered by a firm that specializes in CEFs, has a high visibility partner in DoubleLine, and even offers CEFs of CEFs. Matisse offers both tactical and income-oriented versions of its strategy and does an exceptional job of explaining the closed-end fund universe for potential investors. They’re worth exploring.

But remember: expense ratios tend to be high because they’re investing in underlying CEFs, which charge a lot for their specialized services, and the funds are intrinsically volatile. Remember, you’re buying these (partly) in hopes of exploiting volatility. Your managers are targeting funds that have been irrationally punished, but they can’t guarantee that the punishment will end the moment they arrive.

Bottom line

A rising tide lifts all boats. When tides are rising, and the weather’s good, you’d be wise to find the cheapest sturdy boat you can. Buy a total market index fund and get back to having a life.

But when the tide is not rising, or the seas are surging, you might be served by paying for a fancier boat or a more complex strategy. In theory, CEFs and funds of CEFs give you two market-neutral sources of return: leverage and discount contraction.

This entry was posted in Mutual Fund Commentary on by .

About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.