In a career dedicated to closed-end funds (CEFs), Michael Foster shares how these high-yield investments provided him the confidence to leave his academic job over a decade ago. Despite their reliable income streams, Foster was surprised at the lack of popularity surrounding CEFs, with an average yield of 8.2%. Through conversations with economists, bankers, fund managers, and experts over the years, he came to the realization that CEFs should be more popular and would likely become irresistible after a significant market shock.
The anticipated shock arrived in 2022, as a market crash drove low-information retail investors to exit the market and park their assets in money-market funds. Despite the full recovery of the S&P 500 in the first quarter of 2024, a significant amount of cash from retail investors remains on the sidelines. Some of this cash came from cashed-out CEFs, but the fundamental asset values of CEFs have continued to rise, driving a recovery in their returns across various sectors.
Despite the positive performance of CEFs and shrinking discounts to net asset value, retail investors remain hesitant due to media-driven fears. Historically, CEFs have traded at an average discount of about 5%, which has now decreased to around 7%. However, a year ago, discounts were over 9%, attracting activists to take advantage. As discounts continue to shrink, prominent CEFs like the PIMCO Dynamic Income Fund (PDI) now trade at an 11% premium to NAV, delivering impressive returns.
Foster highlights the case of the tech-focused BlackRock Science and Technology Trust (BST) to showcase the fluctuations in CEF discounts and premiums over the years. Despite a period of heavy discounts, BST’s strong performance led to a premium valuation by 2018. Following subsequent dips in demand, including due to the pandemic in 2020, BST is now trading around par. With retail investors still shying away from CEFs, the potential for more premium pricing exists if they return, as indicated by the rising average CEF discounts.
Looking ahead, Foster suggests that investors could see approximately 13% capital gains on top of current yields by purchasing funds like BST that may rise to a 10% premium if retail investors return to CEFs. With signs of a shift in the market, there is potential for further growth in the CEF space. For more income ideas, Foster recommends exploring Contrarian Outlook’s report “Indestructible Income: 5 Bargain Funds with Steady 10% Dividends.”
