The last teaser pitch I looked at from Brett Owens turned out to be very fortuitously timed — he was teasing several health care REITs as his way to “benefit from the biggest demographic shift in US history” back in early February, and that turned out to be just a few days before the sector bottomed out thanks to the the HCR ManorCare panic that brought down Manorcare’s landlord HCP, which was the standard-bearer partly because it’s the only REIT in the “Dividend Aristocrat” category.
HCP dropped by more than 25% in one day in early February, and pretty much every other healthcare real estate stock was crushed by at least 5-10%, even those who have no exposure to skilled nursing facilities or Manorcare. All of them have bounced back to at least some degree, though those in the skilled nursing/long-term care segment have continued to be the weakest players in the bunch — HCP is still down by 10% from February 1, Omega Healthcare (OHI) is about flat now… the one from Owens that still stands out as weak is Care Capital (CCP), the skilled nursing facility owner spun out of Ventas (VTR). CCP, which another reader asked about yesterday, hasn’t recovered and is still down 12% from that arbitrary Feb. 1 date.
Those kinds of quick panics, when a company-specific problem brings down a whole sector, are often great buying opportunities, even if it seems difficult to buy at the time. There is risk, of course, sometimes those problems really aren’t company-specific… but long-term investors should generally be looking to take advantage of panics by buying at a discount, not selling out of fear. When you have stocks that you think you’d like to own but they’re just too expensive, keep track of them — that’s what I did with Ventas for a long time, I didn’t get a discount “buy” price that tempted me until that panic but when the panic hit I was ready to buy quickly. Keep that list of possible buys somewhere close at hand, and keep a little cash in your brokerage account so you can take advantage of opportunities… you never know when they’ll come.
I don’t know if Owens had any inklings of prescience when he put out that ad for Contrarian Advantage, or if he just got lucky with the timing and considered the generally weak period we were in back in late January/early February to be a good time to pick up income stocks (which it certainly was, in retrospect), but it worked out well… so we’re going to check out another income-focused teaser pitch of his that’s been circulating for a couple weeks.
(If you want to see that earlier pitch of his about health care REITs, a sector where I’m also pretty heavily invested, it happened to be in a Friday File for the Irregulars but I’ve just opened it up for anyone to read here.)
So what is it that Owens is talking up now?
He’s suggesting that we buy closed-end funds, partly because the latest “Bond God,” Jeff Gundlach, has called them out as being priced at an appealing discount. Here’s a bit of the intro for the ad:
“The Bond God’s Top 3 High-Yield Investments
“The best bond manager on the planet is pounding the table about these ‘slam dunk’ income plays. Bank 8%, 8.4% and 11% annual dividends, paid monthly, with 7-15% additional price upside.
“Worst case, he said, these investments will trade flat and we collect a fat dividend. Best case, they’ll return 20%, and we’ll still collect a fat dividend….
“I’m a bit more conservative – anticipating gains that are ‘only; between 16% and 25% over the next year. That’s still a pretty good stock tip from the world’s smartest income investor. The real kicker is, he likes these issues no matter what the S&P 500 does between now and the end of 2016.”
Owens goes through some background that shows why so many folks follow Jeffrey Gundlach’s ideas and commentary — it’s not just that he runs a massive fund of mostly bond investments at DoubleLine Capital and has really taken over much of Bill Gross’s mantle as the most influential commentator on bonds, but he has also made some very solid contrarian calls over the last few years, and presumably made his investors quite a bit of money. DoubleLine manages several dozen mutual funds, many of which have Gundlach as at least a titular manager, so you could always let them manage some of your money if you’re interested… though the funds tend to be fairly expensive.
Owens also includes some quotes from Gundlach about why he likes closed-end funds — the quotes are from the Barron’s Roundtable from back in January (this year Gundlach replaced longtime member Bill Gross), so I’ll just quote that original source to give you a fuller picture:
“… a portion of the credit market has a safety cushion large enough to absorb another 200- or 300-basis-point widening in junk-bond spreads versus Treasuries. I’m referring to closed-end bond funds, which trade on the New York Stock Exchange. Closed-ends are one of the best plays on the Fed not raising interest rates….
“Closed-end funds are leveraged, and investors have been afraid to own them because they fear that the Fed has launched a tightening cycle. Also, based on daily data going back 20 years, they have traded at a 2% discount, on average, to net asset value. Recently, however, the sector traded at a 10% to 12% discount to NAV. It has traded at such a steep discount only 5% of the time. In the past 20 years, the discount has been wider than that only during the financial crisis in 2008-’09.”
He was talking only about fixed-income closed-end funds (meaning, those that invest in bonds — not those that invest in stocks or other asset classes)… and Gundlach actually even suggested a specific closed-end fund:
“Under current circumstances, you have about two percentage points of downside, and 10 points of upside to return to the historical discount. That makes a basket of closed-ends attractive. If you bought a junk-bond-oriented closed-end trading at a 12% discount to NAV, some of the bonds would be trading at a 15% discount. This isn’t a bad idea, but I prefer Brookfield Total Return fund [HTR]. It is trading just as poorly as some other closed-ends, but is vastly safer.
“Brookfield’s NAV is $25.75 a share. It is trading at $21.77, for about a 12% discount to NAV. It pays a monthly dividend of 19 cents, which it hasn’t changed for more than seven years. While investors have been crushing anything that is interest rate-exposed, there is also little ability in the closed-end fund market for institutional investors to arbitrage the discounts.”
DoubleLine also manages a couple of closed-end funds, though Gundlach (appropriately) didn’t specifically try to sell those in the interview — they have the Income Solutions Fund (DSL), which invests in mostly lower-grade bonds right now, and the Opportunistic Credit Fund (DBL), which is mostly in mortgage-backed securities. DBL trades at a huge premium to net asset value (NAV), DSL at a 4% discount. Brookfield Total Return is also mostly a mortgage-backed security fund, at least right now, and trades at a 6% discount to NAV.
So what, then, is it that Owens is touting as his favorite buys in the closed-end fund space?
“Bond God Buy #1 Pays 8.2%
“Buy #1 is a backdoor way to purchase the greatest infrastructure companies in the world at a bargain price. As you know, America’s infrastructure is crumbling after decades of neglect and underinvestment. The American Society of Civil Engineers graded the current state of roads, ports, power plants and water treatment a “D+” in aggregate.
“There are few bright spots, with the ASCE estimating $3.6 trillion will need to be invested by 2020 for upgrades….
“… it’s trading at a 14% discount to the value of the assets it holds! In a knee-jerk reaction, ‘first-level’ investor types have sold this fund along with other energy stocks. But it doesn’t loan money to energy producers – it buys stocks and bonds in the top infrastructure companies in the world. And these holdings are constantly marked to market, so there’s no reason for the fund to trade at such a steep discount.”
This one is almost certainly Cohen & Steers Infrastructure (UTF), which is indeed a closed-end fund, currently trading at about a 14% discount to NAV, which owns mostly infrastructure owners — including utilities, toll roads, cell towers, airports and the like. The data in the tease is probably from the December 31 filing, as of March 31 it has adjusted slightly but the top holdings teased in the ad are still similar — right now the top three are NextEra Energy, Transurban, and Crown Castle — a regulated electric utility, a toll road operator, and a tower company.
The only thing that doesn’t fit as a perfect match here is that UTF pays a quarterly dividend, not a monthly one as is hinted — but I haven’t located a better match. The current dividend is understated in a lot of the finance sites, but they pay $1.60 per year right now as a “managed distribution” so the yield (at about $20 a share) is expected to be 8% annually.
It’s not a bad fund, the expense ratio is not particularly crazy (sometimes Closed-End Funds have huge management fees, UTF is below average for the group) and that’s a tempting discount. Over the last five years you would have been better off (in total return terms) buying a basic utility ETF like the XLU… but not by a huge margin, and UTF would have been more exciting as it did more spiking up and down and does have some infrastructure-type companies that don’t move exactly in line with the utilities (UTF has outperformed the infrastructure index, represented by the IGF ETF, pretty impressively over the past five years… though over the past year IGF and UTF have basically moved in lockstep). The fact sheet from Cohen & Steers is here if you’d like some more basic info.
So that’s not a fixed-income closed-end fund, but it does tend to move with fixed income to some extent because utility stocks are interest-rate sensitive (people buy them for income, so they compete with income investments… and they are also capital intensive industries that have to borrow a lot of money).
And if you’re talking about “closing the gap” to the average discount at which CEFs have traded, like Gundlach was in saying that fixed-income CEFs typically trade at 2% discounts but were at 10% discounts because of rate hike fears, then you need to be aware that UTF’s average discount is very large — it has varied substantially, but averages 12% over the last ten years, so closing that “gap” and getting the discount down from 14% to 12% (or even 10%) would not provide a windfall.
The best you could hope for is that the discount could be cut in half if people get excited about utility stocks or interest rates fall, and that would add another 8% or so to the fund price… which provides some nice leverage if the fund NAV is also rising. So you can calculate an optimistic scenario that gives you the 8% distribution, 7% more from the discount getting cut in half, and another maybe 5% because the stocks rise and the NAV rises, so that’s potentially a 20% gain. It can lose value or trade at a steeper discount too, of course, particularly if interest rates rise quickly, but that’s the most upside I’d look for from this price and it’s probably safest just to consider it an interest-rate-sensitive high-yield investment. Do note that seasonally the best time to buy high-discount closed-end funds is in November and December, because that’s when investors harvest their tax losses and sell their weaker-performing investments and therefore the discounts are usually at their peak then — but, of course, that assumes the particular fund is not closing a gangbuster year at that time.
What’s next from Contrarian Advantage?
“Bond God Buy #2 Pays 8.7%
“Buy #2 has double contrarian appeal. Investors ditched it throughout 2015, concerned the Fed was about to embark on a sustained rate raising campaign (which, of course, never materialized).
“Then, to kick off 2016, these headline-fearing folks avoided anything they perceived to be tied to China. In fact, they sold this fund simply because it has “Asia” in its name!
“These dual panics are the reason fund trades at a 12% discount to its underlying assets. Given its steep sale price, you’d think it’s holding the debt of some obscure Chinese companies. But that couldn’t be any farther from the truth.
“It actually holds safe government bonds in financially-stable sovereigns such as Australia, India, and Korea!”
He also says that the fund has been around for almost 30 years, and has been repurchasing shares when they trade at a discount… and that “this is the best time to buy this decade” (the dates on the sample charts he provides is March 24, 2016, so presumably that’s when he first recommended the fund) … so, what is it?
This is the Aberdeen Asia-Pacific Income Fund (FAX), and it does indeed have a trailing distribution yield of about 8.7% (as with most funds, including UTF noted above, that yield is higher than their actual coupon income — funds juice their distributions by using leverage, capital gains, and return of capital to keep the distribution steady… which is partly why the net returns for long periods are often low, because they sometimes pay out more than is really sustainable).
Even with that relatively high payout, the total return has been negative (down about 6% now) for folks who bought the fund five years ago… presumably, at least in part, because of the strength of the US$. I don’t know if they hedge against currency risk at all, but the dollar’s rise (increasing 46% against the Aussie dollar, for example) has very likely been a drag on US$ returns from their Australian bonds. That’s the extreme case, because of Australia’s disastrouos sensitivity to falling commodity prices over the past couple years, but most currencies have fallen against the US$.
So this is certainly a bit “contrarian” — and it’s very heavily weighted to Australia. You can see from their latest fact sheet that Australia represents about 40% of both their currency exposure and their portfolio, and the next countries on the list get dramatically smaller allocations… 13% for China, 11% South Korea, 9% India, 6% Indonesia, etc.
Interest rates in most of developed and developing Asia are still quite high, other than Japan — South Korea and Australia are well above the US rates at 1.5-2% for their equivalent of the “Fed Funds” rate, and Indonesia and India are several times that amount… so you do get some much higher nominal returns to go along with your currency risk and whatever other risks you think you’re taking by lending to companies and governments in those countries.
The discount for FAX has gotten very high a few times, mostly during regional or international crises where it has spiked over 20%, but for the past decade the discount has averaged about 7% — so with the current discount over 12% there’s at least theoretically some room to “close that gap” … particularly if the Australian Dollar does well. Much of the lending outside of Australia is in either US$ or in currencies tied to the US$, so it’s not likely to be particularly sensitive to the other regional currencies.
One more? Sure!
“Bond God Buy #3 Pays 11.3%
“Finally we have an 11.3% yield brought to us by the Bond God himself – with 8% upside to boot.
“We’ve talked a lot about discounts – there is a flipside. Premiums exist, but they are rare in the closed-end space. And usually reserved for “rock star” managers and hot ideas.
“For example, PIMCO’s funds would often trade at a premium when Gross was running the show. In fact, three still do trade at double-digit premiums, with the most excessive above 80% today….
“In 2012, DoubleLine launched a closed-end of its own. Not surprisingly, it trades for a 17% premium to its NAV today. Investors, in other words are paying $1.17 for $1.00 just to get in with the Bond God.
“As you know, the investing odds are against you when you run with the crowd with a popular trade. But there’s actually a contrarian income opportunity in DoubleLine’s second, lesser known fund.
“You see, this ‘stepchild’ fund launched at an unlucky time – when investors fretted about the possibility of higher rates. Thanks to initial interest rate paranoia, it actually trades at an 8% discount to NAV – even though it’s managed by the same team and provides the same flexibility for them to invest in their best fixed income ideas.
“Even better, this ‘other’ DoubleLine fund pays a whopping 11% yield after fees!”
This is the DoubleLine Income Solutions fund (DSL), which has paid out about 11% as the distribution — though it’s not at an 8% discount anymore, investors have paid up a bit more to get into Gundlach’s fund and it’s now trading at about a 4% discount.
This fund is more or less a “go anywhere” bond fund, but they are focused on high current income (the actual fund income is 8%, so it comes close to covering the 11% distribution). As of the April update, about 45% of the fund is in emerging market debt and the rest is spread among high-yield corporate bonds, mortgage-backed securities, and other stuff… but that can change pretty quickly if Gundlach and his team change their strategy. I’d certainly buy this one before buying DoubleLine’s other fund (dBL) at a now-13% premium, but a 4% discount is not particularly dramatic.
If you’re considering a fund with only a 4% discount, it’s also important to note that the discount can go to 20% (or higher, I suppose, that’s just an example) if investors turn against the sector — so there’s a disjointed risk/reward scenario possible. In that case, it might be worth looking at DoubleLine’s traditional mutual funds if you just want exposure to Jeff Gundlach’s management — those can always be sold at NAV, so you don’t have to worry about discounts, and the expense ratios are a bit smaller for the traditional open-ended mutual funds.
Unfortunately, the performance of the global and emerging markets income funds from DoubleLine has not been fantastic — more than half of their funds that I browsed through on the website trailed their indexes over the past several years, and it’s hard to pay 1.5% expense ratios for any bond fund in such a low-rate environment. DoubleLine is still fairly new, having been founded in 2009, and many of the funds are only a couple years old — so there’s not much of a track record in the specific offerings they have today, and investing with them does require a little bit of a leap of faith… but it is, at least, pretty clear that they’re not “closet indexers”, they really are trying to make different and contrarian choices in the fixed income space.
So there you have it — three closed end funds, trading at discounts to NAV and paying pretty high yields. None of them jump out as being unusually fantastic to me, but they’re reasonable and certainly better than some of their competitors — and these kinds of investments tend to be interesting ones to keep on a watchlist for those “maximum pessimism” periods when the discount to NAV gets truly ridiculous.
And, to be clear, the “Bond God” is not likely invested in any of these and didn’t recommend these specific funds, these are the funds teased by Brett Owens that he likes for his Contrarian Advantage subscribers. Jeff Gundlach’s suggestion was to buy fixed-income closed-end funds, but he doesn’t buy them (institutional size investors can’t buy these funds in general, they’re too small), and the average discounts for funds are a bit lower now than when Gundlach was making those recommendations during the nasty market in January… but he is, at least, involved in managing one of the funds teased.
Any interest in those funds? Think you’ve got some better discount CEF ideas or income investments? Let us know with a comment below.
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