Tuesday, July 23, 2013

CEF Portfolio as of 7/22/13

I will periodically publish a table showing my positions in closed end funds (CEFS). This portfolio is a balanced world portfolio developed primarily for income generation and secondarily for capital appreciation. 

Since that I time, I have purchased mostly bond CEFs, as noted below, and some shares with dividends. Bond CEFs have fallen significantly in price since 5/8/13.

Click To Enlarge:

CEF Portfolio as of 7/23/13

I have purchased the following since 5/8/13:

Added 70 BTZ at $12.63 (7/13/13 Post)

I will discuss in my next post buying 50 shares of NPI at $12.45, averaging down from previous purchases noted above. 

Due to the decline in bond CEFs, I have changed most of my distribution options to reinvestment. 

I have sold the following since the May update:

For bond CEFs, I currently buying up to $1,000 per week, as long as the prices continue to slide and the discounts to net asset values per share continue to widen, for the reasons discussed in Item # 4 to this 7/13/13 Post: Stocks, Bonds & Politics 

I will copy the relevant discussion here:

Rationale: For the next two years, and probably longer, I am not going to earn anything by keeping money in a money market account. My main taxable account has about 20% in cash earning nothing.

I am trying to balance the desire for some income with the potential principal losses inherent in buying bond funds now. I have for now arrived at a balance where I will invest up to $1,000 per week in a bond CEF and reinvest monthly dividend distributions to acquire more shares. That balance was struck after considering the following items.

(1) The declines in market prices for bond CEFs are substantially higher than the declines in net asset values per share, and the discounts now exceed the averages for 1, 3 and 5 years. As the price falls more than the net asset value, I increase my current yield with new purchases, and the yields are attractive in the current abnormally low interest rate environment.

(2) Inflation expectations over the next 10 years remain low and would cap bond losses due to interest rate normalization provided that expectations remains close to 2% per year.

(3) Short term borrowing costs are likely to remain low for several more years for two reasons. The FED is likely to continue ZIRP into 2015, which will anchor short term rates near zero, and will likely raise its federal funds rate much slower than in previous tightening cycles. So, the cost side of the interest rate spread is likely to remain favorable for leveraged bond CEFs for the next 2-3 years and possibly longer. I would add the usual caveat. I would not want to own a leveraged bond fund when both short term and long term rates are rising, particularly when the later increases are due to accelerating inflation and inflation expectations.

Risks: The process of interest rate normalization will be difficult as I have noted many times previously. Stocks, Bonds & Politics: The Difficult Path to Interest Rate Normalization As long as bond prices are moving down and yields up, investors will continue to flee bond funds and bond CEFs in particular, placing additional downward pressure on pricing of bond CEFs that is likely to exceed the percentage decline in net asset value.

That pricing action is a known risk for CEFs since the pricing is not dependent on the closing net asset value, which is the case for a bond mutual fund, but on the supply and demand factors characteristic of a common stock, with no mechanism available to bring price back into line with net asset value per share which exists for bond ETFs.

The foregoing presents a risk but also an opportunity to acquire assets at discounts to net asset value per share, which increases the investor's yield compared to a bond mutual fund selling at net asset value, and the yield increases as the discount expands, just like buying a bond at a discount to its par value.

The problem is that the discount can continue to widen after purchase which is then made worse by a concomitant diminution in net asset value per share. Leverage aids to the losses as the assets bought with borrowed money decline in price.

Leverage adds potential risks and benefits. The benefits are a higher yield due to the spread between the short term borrowing cost and the higher yield paid by the bonds purchased with those borrowed funds and more of a net asset per share gain when the assets purchased with borrowed funds are increasing in value which has not been the case recently of course.

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