The NAVigator

John Cole Scott, chief investment officer at Closed-End Fund Advisors -- the chairman of the Active Investment Company Alliance -- takes a look back at the challenging times experienced by the closed-end fund industry this year, noting that all the news wasn't bad despite slower-than-expected growth for the industry and bigger-than-anticipated losses on the market. His basket of five funds for 2022 came out ahead of the market and, like many parts of the industry, is poised to rebound in the new year.

Stacey Morris, head of energy research at VettaFi -- part of the team involved in the Alerian Energy Infrastructure Index suite -- says that energy markets are likely to remain tight and keep dealing with inflation in 2023, both of which can be tailwinds to energy companies and especially midstream companies, but she notes that the midstream/pipeline companies have cash-flow stability that makes them the more-defensive options in the energy space, and particularly attractive in a recessionary environment.

Steve O'Neill, who co-manages the closed-end fund trading strategies and oversees the closed-end fund analysts at RiverNorth, says the timing is right for closed-end fund investors looking for big discounts that will likely be shrinking right after the turn of the year as the tax harvesting process plays out. O'Neill discusses how the big discounts amount to extra gravy for investors hungry for better yields.

Chris Oberbeck, chairman and chief executive officer at Saratoga Investment Corp. -- one of the industry's largest publicly traded business-development companies -- says that BDCs have been a relative sweet spot during this year's troubled times largely because they benefited from being on the front end of rate hikes and turning them quickly into cash on the bottom line. While the companies must also deal with higher costs, he expects the trend to continue for at least as long as the Federal Reserve keeps projecting higher rates, which he thinks will be well into 2023.

With holiday shopping bargains on everyone's mind, John Cole Scott, chief investment officer at Closed-End Fund Advisors -- the chairman of the Active Investment Company Alliance -- sorts through the big discounts in the closed-end fund world to come up with the best bargains, the most meaningful plays now, based not just on current sale prices but the value and income streams investors can unlock. In his search, he identified two equity and two fixed-income funds that might be a good addition to any investment shopping list.

Michael Grayson, portfolio manager for First Trust Capital Management -- where he oversees their Alternative Opportunities, Private Credit and Real Assets funds -- says that investors should be sacrificing some liquidity for the flexibility to get different assets into their portfolios and to have investments that capture most of the upside in bull-market times while protecting capital during market dislocations. That's how the funds he manages have fared over the last two years and he says that current market conditions are bringing out the best properties in interval funds, making them more attractive for investors now.

Mitchel Penn, managing director of equity research at Oppenheimer & Co., says that business development companies have seen yields rising in line with higher interest rates, a trend he sees continuing while the Federal Reserve continues hiking rates. The higher rates have resulted in more credit risk with more borrowers struggling to make payments; as a result, unrealized losses at BDCs have increased, and while those setbacks remain within expected ranges this year, investors will want to watch the trend to make sure losses don't grow wildly if rates keep rising and/or remain high for several years.

John Cole Scott, chief investment officer at Closed-End Fund Advisors -- chairman of the Active Investment Company Alliance -- says that today's rate uncertainty has created attractive entry points for some municipal-bond funds because they are trading at big discounts and, in many cases, have gone through a dividend cut, thereby reducing the potential for another cut moving forward. Scott doesn't minimize the pain the muni funds have experienced this year, but notes that investors who are brave enough to double-down should be rewarded as the rate cycle plays out, although he cautioned against looking at yield as the selling point rather than combining yield with discount and net asset values to determine the best opportunities.

Mark Milner, senior investment strategist at Parametric Portfolio Associates, says that a lot of asset classes of closed-end funds have now reached double-digit discount territory, "which historically has been a good opportunity to buy closed-end funds," noting that current discounts allow investors to add to their portfolios or rebalance into funds creating greater value for their money. Milner does worry that year-end tax-loss harvesting in 2022 will be higher than in years past as a result of the large market drawdown earlier this year -- but is hopeful that the compelling values will convince investors to reinvest the proceeds of those sales back into closed-end funds, which would help to minimize the potential impact all of that money movement.

Gretchen Lam, senior portfolio manager, Octagon Credit Investors -- sub-adviser on the XAI Octagon Floating Rate & Alternative Income Term Trust -- says that while economic conditions are challenging and that a recession will be bad for the credit markets, collateralized loan obligations and other loan products have held up relatively well during the current period of rising rates. They haven't been able to avoid the downdraft, she says, but they have outperformed other forms of credit, maintaining a historical pattern of superiority in tough conditions. Coupled with low default levels -- which she expects to rise a minimal amount despite higher interest rates -- it creates an opportunity for credit investors now.

Duncan Farley, portfolio manager at BlueBay Asset Management and manager of the BlueBay Destra International Event-Driven Credit Fund, says that the current economic and market conditions that are making headlines and rattling investors are actually creating something of a 'perfect storm' of opportunities that should make it easier to profit from alternative credit investments moving forward.

Robert Bush, senior vice president and director of closed-end products at Calamos Investments, says that convertible securities -- a hybrid product built to give investors the best of stock and bond performance -- have not been giving investors their cake and letting them eat it too this year, underperforming both stocks and bonds, but he says that positive returns to the end of the third quarter and the way convertible funds have held up relative to fixed-income funds suggests that convertibles should deliver better on their purpose moving forward. Bush also discusses two of the firm's funds, comparing a long-short strategy to a total-return fund and discussing how they have fared -- and what has happened to their discounts -- this year.

John Cole Scott, chief investment officer at Closed-End Fund Advisors -- the chairman of the Active Investment Company Alliance -- discusses and compares floating-rate and senior loan funds with preferred-securities funds, noting that floating-rate funds are a tool for combating high and rising interest rates, while preferred equities are a good weapon for battling a recession. As a result, investors in today's complex market may want to "split the ticket," using both types of funds to bolster their portfolio; he looks at the characteristics of each asset class, and has fund suggestions in each category for investors to consider.

Mark Scalzo, chief investment officer at Validus Growth Investors -- portfolio manager for the newly listed Destra Multi-Alternative Fund -- discusses the outlook for alternative investing, the process his fund went through in changing its status and becoming one of the few new listings on the New York Stock Exchange this year, and how that conversion and some other factors have led to a discount that is much bigger than average or than most closed-end fund investors would expect.

Kyle Brown, president and chief investment officer at Trinity Capital, explains how the company's structure helps to support double-digit yields and makes them more secure than other high-yield investments, but also discusses the business development company's exceptionally high yield relative to the rising interest rate and high inflation rates of today. He also talks about how those conditions impact the high-growth, venture-backed, early-stage companies that Trinity finances.

Cheryl Pate, senior portfolio manager for the Angel Oak Financial Strategies Income Term Trust, says that community banks stand out as a part of the financial sector that is poised to benefit into 2023, as banks will likely see the bulk of continuing rate hikes fall directly to the bottom line. Even with that boost, however, she favors bank debt right now compared to holding bank stocks, noting that banks had an excess of deposits generated during the pandemic period and that is being flushed from the system and fee income is falling due to lower loan growth and higher costs, which have created headwinds to earnings. With capital levels at multi-year highs and high levels of liquidity and reserves, Pate sees opportunity in banking-sector debt now that coupons have been "rising nicely," plus she sees community banks as attractive merger candidates which should give a boost to their paper as transaction activity increases into next year.

Josh Duitz, deputy head of global equities at Abrdn -- portfolio manager for Abrdn Global Infrastructure Income and two of the firm's dynamic dividend funds -- says that the macro drivers for infrastructure -- globalization, upgrades and repairs, urbanization and increased demand -- coupled with current inflationary pressures have created an environment that is solid for recession-resistant infrastructure stocks. Meanwhile, with rising interest rates pushing demand higher, dividend stocks have been outperforming as well, and are likely to continue to remain in the market's sweet spot until the economy rebounds and convinces the public that it wants to focus again on growth rather than looking at total return. Duitz says that among dividend plays, he is most interested right now in sectors that can raise revenue to keep pace or stay ahead of inflation, so that they are not squeezed by the macro picture, which means the most-fertile hunting grounds now tend to be among health care, real estate, materials, industrials, utilities and consumer-staples companies.

Kenneth Burdon, an attorney in the investment management group at Skadden, Arps, Slate, Meagher & Flom, says the new "control share" statute enacted at the start of August by the state of Delaware should protect should protect investors from activist investors acting like corporate raiders trying to force a pop to net asset value without regard to what the broad group of shareholders is interested in. The law forces further negotiation between the board and outsiders, Burdon says, giving directors cards to play when activists come to the table.

Roxanna Islam, associate director of research at VettaFi -- which developed the the S-Network Composite Closed-End Fund Index and other benchmarks for the closed-end fund space -- discusses the construction of indexes of closed-end funds and the benefits to using them over individual issues, as well as how passive investing in the space has held up against active management during the rough start to the year.

Bryce Doty, senior portfolio manager at Sit Investment Associates, says that the market's troubles this year have set closed-end funds up to be in a sweet spot, able to generate additional returns that traditional mutual funds and ETFs can't get investing in the same spaces. Despite those potential benefits, Doty acknowledges that most investors shy away from closed-end funds for a lack of understanding, and also miss out on the benefits of running closed-end funds as a portfolio or bucket of money, rather than as a single investment or two that's part of a larger portfolio.

John Cole Scott, chief investment officer at Closed-End Fund Advisors and the chairman of the Active Investment Company Alliance, discusses some equity and fixed-income funds currently trading at premiums and compares them with similar funds priced at a discount, noting that expenses, payouts and more determine relative values. Further, he notes that when the market takes a dive and discounts widen, investors should consider whether the best bargain is the fund with the widest discount or the fund whose premium has evaporated.

Portfolio manager Tim Ryan of Nuveen -- who runs the Nuveen Dynamic Municipal Opportunities closed-end fund -- says that after a miserable first half of 2022 that lagged Treasury bonds, conditions have stabilized for muni bonds, which now have a more attractive yield curve and offer a better investment opportunity than Treasuries. Ryan says that the first-half selloff was more about technicals than about the quality of the underlying municipal bonds, which means that when the interest-rate picture stabilizes investors will worry less about credit quality in munis than in other areas in fixed income.

Timothy Reick, chief executive officer at Liberty Street Advisors -- advisor to the Private Shares Fund -- says that private equity is an asset class that is not correlated to the broad stock market, and that individual investors largely overlook its potential role in their portfolios. Reick notes that with private companies waiting much longer both in terms of time in business and the asset size they grow to before turning to public markets -- if they ever go that route -- investors will find a vibrant market that they can approach in many different ways. Private Shares Fund is an interval fund that pursues mostly late-stage firms, but he notes that the space includes everything from angel investors to companies on the verge of going public, across virtually all businesses and industries.

John Cole Scott, chief investment officer at Closed-End Fund Advisors and the chairman of the Active Investment Company Alliance, says that business-development companies -- which are built to handle a four-year business cycle -- are looking at positive surprises as second-quarter earnings season arrives. From July 26 to August 10 -- when the bulk of BDCs will report earnings -- Scott says that BDC discounts are currently about 13 percent wider than media discounts have been over the last two decades, and that there has been very little uptick in problem loans, which sets up a potential rally. Scott notes that BDCs have outperformed closed-end funds during the rough first half of 2022, and identifies several BDCs poised to deliver good yields, mostly at a significant discount now.

Rob Shaker, portfolio manager at Shaker Financial Services, says that the closed-end fund market showed signs of a "sympathy widening" in mid-June, an event when there is "excessive liquidation selling based on fear," leading to a bad day on the stock markets and bond closed-end fund discounts widening at the same time. Shaker says it can be a sign of a market bottom, which can lead to a bounce-back; still, he says, markets remain fragile and there could be more excessive selling again, though it hasn't happened since June 16. Shaker also noted that the first half of the year saw trouble for closed-end funds, but the behavior of discounts was very different for equity and bond funds, with fixed-income issues seeing a much more dramatic widening than stock funds.

Ben McCulloch, managing director and general counsel at XA Investments, says that the last five years have seen over $40 billion in growth in interval funds and tender-offer funds, and that interest has attracted more fund sponsors -- including companies that have been heretofore more focused on ETFs -- and more new ideas. That has brought with it increased regulatory scrutiny, as the Securities and Exchange Commission is evaluating what kinds of alternatives -- particularly with private-equity and venture-capital investments -- are right for the interval fund structure, but McCulloch sees the growth and the expansion of interval offerings continuing, with more new and different funds on the horizon.

John Cole Scott, chief investment officer at Closed-End Fund Advisors and the chairman of the Active Investment Company Alliance, returns to The NAVigator to answer questions frmo listeners, including one on whether it makes sense to do tax-loss selling now rather than waiting for the traditional period for making swaps at the end of the year. Scott recommends closed-end fund investors tap their "tax assets" when they are valuable, and losses in today's market can be turned into a benefit easily. Scott also answers a question on the slow speed of recovery in the energy sector, and gives his take on how the across-the-board pullback is affecting different sectors of closed-end investments and how recovery has occurred after previous downturns.

Larry Holzenthaler, investment strategist and analyst for Nuveen, says that "floating rate loans actually look arguably cheap to us today," acknowledging that it's surprising that the asset class is trading at a discount "in the middle of one of the most brutal rate-hike campaigns we have ever seen." Holzenthaler -- who also covers the high-yield space -- says that senior loans have been one of the few places where investors have avoided much of the pain in the fixed-income markets, making them feel like a safer haven and a relatively good value.

In this bonus episode of The NAvigator, Jonathan Browne, director of research at Robinson Capital and portfolio manager of the Robinson Funds talks about how balancing closed-end fund investments with pre-market SPACs [special-purpose acquisition companies] creates opportunities for higher yields with diversification that helps to balance out risks.

Sam Brothwell, director of research at Energy Income Partners, says that the current cycle of under-investment in capital spending has made it harder for energy producers to respond to the current global supply-demand imbalance; that has pushed energy prices -- for oil, natural gains, electricity and alternatives -- dramatically higher, where they are likely to stay, even as energy companies work to increase capacity and respond to market conditions. Brothwell says that investors should respond to current conditions by diversifying their energy holdings as legislators and corporate executives wrestle with economic issues while searching for solutions.

With the volatility and downward pressure in the market pushing many investors to specialty funds, sector offerings and alternatives, John Cole Scott, chief investment officer at Closed-End Fund Advisors and chairman of the Active Investment Company Alliance returns to the NAVigator this week to talk about some funds that are more basic in strategy, core holdings by nature, and highlights five that represent good values and opportunities now.

Nicholas Marshi, editor of the BDC Reporter, says that business-development companies had a good first-quarter across the board, despite troubles across the broad market. After seven quarters of BDC's generally increasing net asset value per share, and while that growth decelerated during the first three months of 2022, Marshi says it was a "hinge quarter," where inflation, higher interest rates and more started to creep into results. He notes that business-development companies are poised to benefit from higher interest rates without suffering significantly higher credit losses in the process; as a result, he's bullish on BDCs now, even in the face of an economic slowdown.

Duncan Farley, portfolio manager for BlueBay Asset Management and co-manager of the Destra International Event Driven Credit Fund, says that today's headlines are driving more companies to distraction and creating the types of problems that he sees as investment opportunities. His fund has taken advantage, posting double-digit gains while most of the market has moved in the opposite direction, and he believes that investors willing to buy discounted credits will be rewarded if they can ride through the macro headlines to hold onto bargain credits until economic conditions improve.

Bill Kelly, president of the CAIA Association, discusses the importance -- which he believes is mostly misplaced -- that many investors place on having daily liquidity in their investments, even though they have no intention of touching the money in the short term. The result of these mis-aligned time frames is that investors pay a real price for liquidity they neither want and need; the offshoot of this thinking is helping to drive the expansion of new issues for closed-end and interval funds, Kelly says.

John Cole Scott, chief investment officer at Closed-End Fund Advisors and the chairman of the Active Investment Company Alliance, talks about the search for closed-end funds that can deliver in rising-rate, high-inflation conditions, talks about five issues from different categories that pass muster now, and explains how in today's business-development company space, "Sometimes discounts are expensive and premiums are cheap."

Nathan Shetty, head of multi-asset for Nuveen and co-manager of the Nuveen Multi-Asset Income Fund, discusses the importance of using proper allocations to generate reasonable and consistent total returns in a low-return environment. Shetty notes that proper diversification and risk management are particularly important in times like today, with so many wild cards, headline risks and uncertainties.

Mike Taggart of Taggart Fund Intelligence -- executive director of the Active Investment Company Alliance -- reviews the first-quarter results for closed-end funds, noting that discounts widened out during a rough period for the market, reaching a crossroads where investors are trying to decide now if the discount has hit a level low enough to represent a good risk premium and a buying opportunity. Taggart also discusses interval funds, the focus of an upcoming AICA educational event, and how the growth in the space is giving investors interesting opportunities in alternatives.

Bob Long, chief executive officer at Conversus -- which manages the Conversus StepStone Private Markets Fund -- returns to the NAVigator to discuss private equity and how investors looking for success must commit to overcoming the J-curve, the start-up period when private-equity investments tend to lose money in the early days in order to be positioned for long-run success. Individual investors wanting to avoid the pain of those start-ups through diversification are increasingly turning to interval funds and business-development companies in the space, finding assets that are less correlated to the stock market, but which can ride out the volatility of the J-curve to benefit from start-up and private-equity exposure.

Steven Bavaria, author of "Inside the Income Factory" on SeekingAlpha.com, says that current market conditions have shown the value of focusing on income streams rather than the value of the underlying securities, allowing investors the peace of mind that comes from generating cash-flow and putting that money back to work buying at a discount. Bavaria noted that when a manufacturing company builds a production plant, they don't worry about the resale value of the factory but instead focus on its output; he says investors should act the same way, focusing less on the fluctuations in value of their investments and more on getting consistent, above-average yields, which provide a comforting cash stream that makes tough times -- like the first quarter of this year -- much easier to stomach.

Michael Bell, founder of Primark Capital -- which runs the Primark Private Equity Investments Fund, a closed-end interval fund -- discusses how changing market conditions have reduced the number of public companies and dramatically increased the number of available private equity investments, which he says are best handled in the limited-liquidity structure of an interval fund. It creates an opportunity to buy brand-name middle-market companies that investors can't access in traditional funds.

Mitchel Penn, managing director of equity research for Oppenheimer and Co., talks about the challenges of analyzing and evaluating business-development companies, and then highlights Runway Growth Finance Corp. -- which his firm expects to outperform the market and competition -- to show the methodology in action and to showcase the place BDCs should occupy in diversified investment portfolios.

Eric Boughton, chief analyst at Matisse Capital and portfolio manager for the Matisse Discounted Closed-End Fund Strategy, says that the war in Ukraine has been creating deep discounts and bigger buying opportunities for closed-end fund investors, noting that emerging markets and international stocks went into the conflict already at low levels, which now means investors are getting 'a discount on a discount.' He notes that international equity closed-end funds now are trading at a median discount of 12 percent, compared to a long-term discount of 10 percent; international bond closed-end funds now trade at a median discount of 11 percent, compared to a normal average of 8 percent. Those conditions – and wider discounts – should improve investor confidence that the investments can rebound quickly from the war.

Seth Brufsky, chief executive officer for the Ares Dynamic Credit Allocation Fund, says that conditions since the end of the year have changed from concerns over what the Federal Reserve would do, 'changing the calculus' for how people should and will invest. Brufsky says the focus entering the year was on floating-rate investments, but now that there are lingering concerns about inflation and higher rates that -- along with geopolitical concerns -- are forcing investors to re-evaluate priorities but also investment options. Brusky says that fixed-income markets are becoming increasingly attractive in these conditions -- particularly in high-yield bonds, but also with some investment-grade securities -- because the potential for capital appreciation has grown dramatically.

Mike Taggart of Taggart Fund Intelligence, the executive director of the Active Investment Company Alliance, returns to The NAVigator following up on his recent discussion of buying assets rather than discounts by answering some questions from the audience about the persistence of discounts and where discounts fit into the picture once you have purchased a fund.

John Cole Scott, chief investment officer at Closed-End Fund Advisors and the chairman of the Active Investment Company Alliance, says that 20 investment firms have launched 30 new funds under the 'Closed-End Fund 2.0' format since 2019, and the results and opportunities are promising. While the new funds show an average discount over 7 percent, the new structure returns the funds to net asset value after 12 years, which means that some of these funds are long-term bargains right now; he names four of the 2.0 funds that look particularly attractive to him now.

Mike Taggart, founder of Taggart Fund Intelligence and executive director of the Active Investment Company Alliance, says that the stock market's rough January along with the war between Russia and the Ukraine have put the market in a tizzy and widened discounts for closed-end funds by over 1 percent on average this year, but he notes that while discounts have become attractive, they don't make for automatic buying opportunities. Some closed-end funds, Taggart says, will stay at deep discounts and will see the net asset value fall towards the discount instead of rising to create the standard payoff bargain buyers are seeking. He says investors need to want the underlying assets and believe in their potential, rather than simply buying the big discounts.

Chris Oberbeck, chairman and chief executive officer at Saratoga Investment Corp., says that the structure of business-development companies -- which allows assets to increase in value when interest rates rise, while keeping liabilities fixed, thereby raising spreads -- makes them particularly attractive to investors looking for better real yields in a rising-rate environment. Oberbeck explains, generally, how BDCs will be able to weather the first rate increase, whenever it happens, with much less impact than most income investments will experience.

Maury Fertig, chief investment officer at Relative Value Partners, discusses the factors he considers when picking closed-end funds to add to client portfolios, and how those criteria have been impacted by headlines about rising rates and inflation, along with the stock market's heightened volatility and January losses. Fertig says that current conditions have changed some of his focus, moving him away from floating-rate funds -- which were trading at a significant discount a year ago, but which are close to net asset value now -- while convincing him to 'nibble' on some credit and mortgage funds that have fallen off in recent months, becoming more-attractive bargains as a result.

Mike Taggart, founder and chief executive officer at Taggart Fund Intelligence -- the recently appointed executive director of the Active Investment Company Alliance -- talks about his research into how closed-end funds have performed in rising-rate cycles, and also looks at how senior-loan funds perform, noting that the closed-end fund structure can make it harder for senior loans to live up to their narrative as being a plus asset when rates are going up.

Rob Shaker, portfolio manager at Shaker Financial, says that the market's recent struggles have re-started a cycle and repetitive pattern that closed-end fund investors should recognize and take advantage of. It starts when excessive selling pressures -- which the market experienced in January -- results in 'excessive selling' that widens discounts; once those selling pressures ease, the market rebalances and restores equilibrium, and investors take advantage of the bigger discounts to snap up bargains, which then completes the circle by raising prices and narrowing discounts to more normal levels. Shaker says investors should be at the buying point now, particularly for bond funds.