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Changing the CEF Conversation

Morningstar's Mike Taggart addresses how CEF discussions too often miss the broader picture about investing, and he also discusses new developments at Allianz and Aberdeen.

Mike Taggart, CFA, 04/27/2012

This week we attended the Capital Link's 11th Annual Closed-End Funds and Global ETFs conference in New York, which always makes for an exciting week. The day was packed with sessions, but as most of the larger fund families are represented, another draw of the event is to catch up with familiar faces, meet new people, and interact with investors. It's an exciting day.

But before I begin with that, I wish to draw your attention to another bit of excitement that kicked my week off. On Monday morning, I received a call from Martha D., who is the primary liaison for closed-end-fund, or CEF, analysts at Allianz. She rang to inform me that Allianz has now posted on their website detailed earnings and leverage details for the CEFs they sponsor. Having lambasted the fund family for its previous opacity in this matter in several articles (most recently, here), I would be remiss if I didn't congratulate Allianz for adopting best industry practices with regards to leverage transparency. Its new disclosure can be found on its CEF website, selecting a particular fund, clicking on "Documents," and then clicking on "CEF Earnings and Leverage Data." For example, the earnings and leverage data for PIMCO Strategic Global Government RCS can be found here. It's always refreshing to see fund families step up and make large changes for the benefit of their shareholders.

2 Attention-Grabbing Sessions
Capital Link's conference was a full 12-hour event, making it difficult for even a synopsis to do justice to the session. However, I'd like to bring two presentations to your attention. First, Donald Amstad of Aberdeen Asset Management flew in from Singapore to discuss opportunities for investing in the Asia-Pacific region. He has been in our offices a couple of times before to discuss similar topics. Amstad's message, it seems to me, is very important for U.S. investors. Overseas investing, despite the negative headlines emanating from Europe over the past couple of years, remains essential to proper portfolio diversification. Too often, in my opinion, talk about investing in Asia focuses solely on the rapid growth of the region. To Amstad, it seems that to focus solely on the region's growth is to largely miss the broader sweep of what is occurring. In his argument, while the so-called developed countries of the West are languishing in debt, the Asian region has a relatively pristine balance sheet. While many investors wonder about the future of the euro, several Asian countries have banded together and have now started to use the Chinese renminbi to settle international trade. In addressing this issue, Amstad concluded that "we are witnessing the birth of a new international reserve currency." It was a very sobering address. To get a sense of his message, you can go to the Capital Link website to see his presentation slides. The session made me realize, once again, that while we focus day to day on the changes in U.S. markets, our attention for the long term should likely be focused on the tide of history changing the other side of the world.

The second presentation that struck me was delivered over lunch by Morningstar's director of ETF, closed-end, and alternatives research, Scott Burns, (full disclosure--he's my boss) and focused on CEFs. Now, to put Scott's presentation into context, I should first step back and explain something. I've been covering CEFs for a little over two years now. In that time, the discussion about CEFs--both by our team, other industry analysts, and industry executives--has largely been on the same topics. And, to be sure, those same topics were present throughout the conference. Yes, there was the obligatory (and still important) session about leverage. Yes, investors were reminded about the difference between "good" and "bad" distributions. But I believe Scott brought something new to the table, something that had been hinted at by Lewis Aaron, the conference chairman and the founder of Fund Consultants.

In his opening remarks at the conference, Aaron took a look back at the performance of open-end funds and CEFs in 2011. Using Morningstar data and categories, he laid out the superior total returns logged for CEFs during the year and also for the three-year period ended Dec. 31, 2011. To us, this is not surprising. What caught my attention, though, was that of all the topics he could choose to open the conference, Aaron chose to bring this matter to the attention of CEF industry executives and their investors. It's something I hadn't seen before at a CEF conference.

Scott's presentation continued this shift in the conversation around CEFs. Essentially, he urged the industry to get its focus out of the weeds and to look at the bigger picture. Risk is everywhere. Of course, we want better leverage transparency, but at the end of the day, data show that for long-term investors leverage is a positive element. While some investors eschew CEFs because they hear about leverage, they forget that--on a total assets/total equity basis--blue chips such as General Electric GE, McDonald's MCD, and Wal-Mart WMT are leveraged to multiple degrees more than any CEF. While CEF investors worry if their distribution is safe, we need to remind that in 51 of 54 Morningstar categories the average CEF has a higher distribution rate (excluding any return of capital) than the average open-end peer. Indeed, although I had helped Scott put the slides together, after reflecting on his entire presentation, I realized once again that far too often is our discussion about CEFs bogged down by the nitty-gritty details of CEFs.

A Fresh Look at CEFs
We continue to believe that the best approach to investing is to first make an asset-allocation decision and then to consider all investment vehicles available (open-end mutual funds, ETFs, and CEFs) to execute on that decision. Understanding that investment risk is always present, getting a better sense of what the true risks in a fund are and holding on to the investment for the long-term remain the cornerstones for long-term investment success. Getting caught up in the weeds of whether a fund trading at a 5% discount is superior to one trading at a 5% premium, or whether a 6% distribution rate is sufficient and safe, threatens to miss the broader point of whether the fund is suitable in your portfolio and in your risk profile.

Too often what we think we know, whether about Asian economies or about CEF investing, is only part of the story. It's always nice to have our views challenged, to reflect, and to come away with a broader, more solid understanding. The Capital Link conference has always served to complement our views on CEFs. This year, I believe, it also brought forth a fresh perspective on the broader role of CEFs in investors' portfolios.

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Mike Taggart, CFA, is the director of closed-end fund research at Morningstar.
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