CEF Weekly Review: Activists Are Coming After Muni CEFs

Welcome to another installment of our CEF Market Weekly Review, where we discuss closed-end fund (CEF) market activity from both the bottom-up – highlighting individual fund news and events – as well as the top-down – providing an overview of the broader market. We also try to provide some historical context as well as the relevant themes that look to be driving markets or that investors ought to be mindful of.

This update covers the period through the fourth week of February. Be sure to check out our other weekly updates covering the business development company (BDC) as well as the preferreds/baby bond markets for perspectives across the broader income space.

Market Action

It was another solid week for CEFs with all but one sector NAV (Convertible) moving higher. Discount action was more mixed. Month-to-date, only three sectors are in the red – the higher-quality / higher-duration credit sectors. These have struggled in light of the 0.4% back-up in Treasury yields over the month.

The average CEF sector discount has rallied off its 2022 double-digit level and remains a couple of points wider of its average level this century.

Muni CEF sectors, along with MLPs and a few Equity sectors, remain on the wider edge of the discount spectrum. As we discuss below this has attracted the attention of a number of CEF activists.

Market Themes

As the chart above shows, Municipal CEF sectors continue to feature relatively wide discounts in the broader CEF space. Not only that but Muni CEF discounts are wide relative to their own history as the chart below shows, despite rallying somewhat off their wides last year.

This has attracted the attention of a number of CEF activists, most notably, Karpus. CEFs are around 60% of Karpus total $3.7bn holdings which is not all that much however it can make a dent in the CEF market which is itself not that big at around $240bn with many fairly small funds. Karpus is coming back to CEF because it views discounts as “unprecedented”.

The Karpus CIO said “when discounts remain wide for extended periods of time, we believe the board of directors and fund management companies have an obligation to take action to reduce or eliminate the discount. So far they have failed to take action.”

We can see a recent update of the 13D/G Karpus filings from our CEF Tool below.

As expected, the company is focusing on funds like MUI, NRK, NEA and EIM that trade at double-digit discounts. The activists will tend to blame management for double-digit discounts which is useful for them. However, the wide discounts in the Muni CEF sector are not a coincidence nor are they the fault of managers.

Ultimately, the discounts are there to compensate for the flatter yield curve today than in 2021 which reduces the overall level of net income. In any case if the activists can tighten discounts by pushing managers to conduct tender offers it’s not a bad thing even if it is self-serving.

Market Commentary

Allspring (formerly Wells-Fargo) CEFs marginally adjusted their distributions. Recall these funds distribute a percentage of their last 12-month NAV average. This percentage was raised recently which led to a bump in distributions from the previous smooth profile.

Western Asset hiked a number of funds including WDI, DMO, EHI, IGI, SBI, MHF and MMU. The hikes in the three Muni funds were large and feel like they are similar to what we have seen in Nuveen, Blackrock and Invesco Muni CEFs with the difference being that the Western Asset Muni CEF hikes were done in their usual cycle. As far as DMO and WDI which are in our Income Portfolios – DMO net income has continued to increase in line with the lag in the rise in short-term rates however the fund does appear to be overdistributing as it has tended to in the past. Interestingly, WDI is overdistributing by less as it also hiked by less than DMO.

CLO Equity CEFs have reported their January NAVs. OXLC was up 3%, ECC was up 0.7%, OCCI was up 0.3% and CCIF was up 0.1%. CCIF has been lagging the upward trend in sector NAVs – it remains to be seen whether its portfolio is simply lower-beta or if there is something else going on. We should know more in a down month.

Stance and Takeaways

This week we reduced our allocation to the term CEF GDO which will go through a tender offer and possible termination. As we have discussed several times, term CEF discounts tend to hold up much better than those of their perpetual counterparts. We can see this in the chart below where the discount of GDO remained resilient while that of the broader sector moved wider since 2022. In short, GDO has done its job by maintaining a very resilient discount profile over the past couple of years. For this reason term CEFs remain a core part of our allocation process.