A breakdown of the CEF team's analyst ratings by firm, analyst, and Morningstar classification.
With the London Olympics winding down, the ubiquitous "medal count" is tallied everywhere. For two weeks, we are bombarded with charts and graphics telling us which country has won the most medals overall, and most importantly, who's leading the gold medal race. In recent years, this has become a competition between the United States and China with most other nations falling vastly behind. So far this year, Great Britain has made a great third-place showing with (as of this writing) 48 total medals, 22 of them gold. This pales in comparison to China's 73 total medals, 34 of them gold, and the United States' 71 overall medals, 30 of them gold.
While the closed-end fund, or CEF, team has been enjoying the 2012 race for gold, we look for gold year round. In the fall of last year, Morningstar launched its new qualitative Morningstar Analyst Rating for Funds (you can read a methodology document here). Since the launch, we have been rolling out coverage and ratings of CEFs and have launched 106 full reports and ratings to date. We thought this would be an opportune time to take stock of our own "medal count." We grouped the ratings by the funds' Parent or Advisor, by Morningstar Classification, and by analyst.
Morningstar's Analyst Rating for Funds
Let's start with a quick review of Morningstar's Analyst Rating for Funds. The rating is qualitative and separate from the Morningstar Rating for Funds (the "Star Rating"). It is based on Morningstar's conviction in a fund's ability to outperform its peer group or relevant benchmark on a risk-adjusted basis. The rating is built around five pillars that we believe inform future performance: People, Parent, Process, Performance, and Fees. (For CEFs, our reports also discuss some CEF-specific issues such as discount and premium, distribution, board of directors, and leverage.) Unlike the Star Rating, which relies solely on historical risk-adjusted performance against a peer group, the Analyst Rating is qualitative and forward-looking. Historical performance plays a minimal role in the rating, with the focus on the fund's managers, the investment process, and the parent firm. There are three positive ratings (Gold, Silver, and Bronze), a Neutral rating, and a Negative rating. The degree of conviction decides which positive rating a fund may get, but the ratings are not designed to predict that a Gold-rated fund will outperform a Silver- or Bronze-rated fund.
Analyst Ratings on CEFs are provided for funds based on net asset value. We attempt to cover the largest funds and any sister funds managed by the same team and utilizing similar processes. In all, we have 106 funds rated with plans to reach about 150 by the end of 2012. While this doesn't seem like many funds (there are about 620 CEFs in existence), many are small and thinly traded. The funds currently covered represent about 55% of the total net assets of all CEFs.
CEF Medal Count
Note that all of the ratings listed in the tables below are as of July 31, 2012. Table 1 shows the total medal count for our entire CEF coverage list. Most of our ratings fall in the Bronze and Neutral category, which is to be expected.
The five Gold funds fall into categories all over the map (see Table 4 for the Morningstar Classification breakdown of medals) and represent only 5% of all rated CEFs. The Gold-rated funds are Aberdeen Asia-Pacific Income FAX, Alliance Bernstein Income ACG, CBRE Clarion Global Real Estate Income IGR, Gabelli Equity GAB, and Royce Value Trust RVT. For a fund to earn a Gold rating, it must have a strong parent (one that is shareholder-friendly and transparent and has a long and stable history), a cohesive management team with extensive experience investing in the asset class, impressive risk-adjusted historical performance, relatively low fees, and a well-articulated and well-executed investment process.
Table 2 lists each rating as a percentage of total rated funds by the team's three analysts. We see a similar distribution of ratings in the breakdown by analyst as appears in the total percentage of ratings. (Mike's list is the exception, but, being the boss, his coverage list is the smallest on the team.)
Table 3 lists the ratings by Parent or Advisor (we've separated PIMCO from Allianz Group because of its notoriety and its success as an investment shop previous to its acquisition by Allianz).
Looking at the largest providers of CEFs (Nuveen Asset Management, BlackRock Advisors, and Eaton Vance Management), BlackRock is the strongest from a percentage of ratings perspective. Of the 21 BlackRock funds with Analyst Ratings, 19% are rated Silver, 52% are rated Bronze, and 29% are rated Neutral. The fund family has no Gold-rated funds but also no Negative-rated funds. Both Nuveen and Eaton Vance have one fund each rated Negative and none rated Gold. Interestingly, it's the smaller shops (those with only a handful of CEFs) that tend to earn Gold ratings. Perhaps this points to the ability of a smaller shop (and its board of directors) to pay close attention to individual funds and subsequent performance and to quickly step in to make changes if necessary.
But the Parent rating isn't everything. We often criticize Allianz Group for its lack of transparency (though it has recently done a nice job of increasing transparency around leverage) and are critical of the persistent premiums at which many of the PIMCO CEFs sell. But Allianz as a whole earned five Bronze ratings (out of 10 total funds rated), and two of them are PIMCO funds. This is a good time to point out that the premium at which a CEF sells does not directly factor into a fund's rating. We're not making a market call on the fund or placing any valuation metric on its share price. PIMCO's funds have strong risk-adjusted returns against peers and benchmarks, its fees are generally lower than or on par with peers, and the portfolio is built around Morningstar Manager of the Decade Bill Gross' assessment of the overall market outlook. Gross has had success with many of PIMCO's CEFs, and their premium pricing reflects this long-term outperformance of peers.
The final table lists the medal count by Morningstar classification.
While we chose to cover the largest funds in the universe, we attempted to have a representation from all major categories (state municipal funds being the exception). The most represented category is municipal funds--not surprising as they make up about 40% of the entire CEF universe by number of funds. Our muni analyst Steve has 14 positive ratings on the 19 muni funds he covers. His coverage list will include more municipal funds in the future, so stay tuned for additional ratings on national municipal CEFs.
The covered-call classification is interesting because we generally do not compare these funds against the covered-call peer group. As the analyst for this group of funds, I compare them to funds investing similarly (large growth or large value, for example) that may or may not utilize a call overlay strategy. This allows for the options strategy to stand on its own outside of the broader investment strategy. It is helpful in determining whether the call options are additive to long-term performance. While covered-call funds have gotten a bad rap over the last few years, we have positive ratings on eight of these funds and neutral ratings on five.
While the breakdowns show a positive-rating bias (more than 60% are rated positively), ratings are not exclusively based on comparisons against CEF peers, but open-end and ETF peers as well. And, as we are not rating the entire universe, just the largest funds, our coverage tends to include those funds that have performed at least reasonably well over the long-term. Finally, funds for which we do not offer a full report and analyst rating are often highlighted in our weekly CEF Spotlight series. You can access the archives here (articles are published each Tuesday).
As always, we appreciate any questions, comments, or suggestions you may have about our coverage lists, the reports, and the ratings. If there is a fund you'd like to see covered, let us know in the comments section below this article. While we many not provide a full analyst report or rating, we will consider highlighting it in the weekly Spotlight series.
Click here for data and commentary on individual closed-end funds.