Are Closed-End Funds Another Sign of a Frothy Market?

Closed-end funds

My American team left me behind to take off for Europe today. They’re going to Ireland before I meet them in Bonn, Germany with Dr. Bauer next week. Of course, if you know me, I’m taking advantage of the quiet time. I’m eating all the ice cream in the fridge, and I’m definitely going through everyone’s stuff… Just kidding. I’m actually focusing more on the state of the markets, specifically closed-end funds. The Federal Reserve is making its decisions today. But I’m not that interested. I expect that the Fed will give this can another kick toward August. We’ll look for actual insight on the state of interest rates during its Jackson Hole meeting later this summer.

I’ve already shown you valuations that show that the market is stretched. We haven’t seen an S&P 500 Price-to-earnings ratio this high since the Dot-Com bubble. But we also know that the Fed is largely driving this round of speculation and not Wall Street’s IPO frenzy.

If you’re looking for another sign of an overstretched and defensive market, look no further than the closed-end fund space.

Closed-end funds are a lot like mutual funds. The primary differences are that there are a fixed number of shares for each fund that trade on exchanges. In addition, they do not trade according to the Net-Asset-Value of the fund. Instead, they trade based on the bullish and bearish sentiment of would-be investors. So, these funds can trade at a premium or a discount to their net asset value.

I’ve shown you a few closed-end funds that are interesting and trade at a discount. For example the Herzfeld Carribean Basin Fund (NASDAQ:CUBA) is a basket of stocks that would perform well if the U.S. improved relations with Cuba. It trades at a 11.9% discount to its NAV and offers a dividend of 10.2%.

Meanwhile, the Boulder Growth & Income Fund (NYSE:BIF) is basically a replication of Berkshire Hathaway’s portfolio. It trades at a discount of 15% to its NAV – and unlike Berkshire – it pays a dividend of 3%. But what about things trading at a premium? That’s where things get interesting.

Eyeing Utilities

When we start to think about playing defense in the markets, we tend to see investments pour into the utility sectors first. They operate in a space where people will need electricity, water, and more regardless of the economy’s health. These firms also tend to pay strong dividends.

So, when looking at closed-end funds with an emphasis on utility stocks, I see a curious phenomenon occurring. The DNP Select Income Fund (NYSE:DNP) owns a wealth of utility stocks like Dominion Energy, Public Service Enterprise Group, and Alliant Energy.

The fund is trading at a premium to its NAV of 8.7%. It also pays a distribution of 7.3%

Two other utility closed end funds – Cohen & Steers Infrastructure Fund (NYSE:UTF) and Reaves Utility Income (NYSE:UTG) – are also trading higher than their NAV. These are the best-in-class funds for their space.

This is telling me that people are willing to pay a premium for these assets because they believe that the underlying stocks are going to increase in price. They expect that the NAV will rise over time and meet the price they paid.

This is quite a signal. The next phase of this will likely turn to other funds that are trading at a discount that would do well in a weaker economic environment or in a state when interest rates might rise. I’m paying very close attention to municipal income funds right now.

If I find something that is interesting and worth your time, I’ll let you know.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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