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Commodities CEFs Tank in September

The Bond King's departure had a small impact on CEF performance compared with the onslaught in the commodities market.

Cara Esser, 10/16/2014

The unexpected departure of PIMCO founder and chief investment officer Bill Gross dominated the headlines at the end of September, but PIMCO investors were far from the most disappointed folks last month. Gold prices dropped 6% in September, continuing a months-long decline from its mid-March high of $1,391.77 per ounce. Since that high, gold prices have fallen more than 13% through the third quarter. The strengthening of the U.S. dollar and improving economy also put pressure on the prices of other precious metals and commodities like oil and gas. This price pressure landed the equity precious metals closed-end fund Morningstar Category at the top of the worst-performing funds list during September and affected other commodities-sensitive categories such as natural resources, Latin America stock, commodities precious metals, equity energy, and emerging markets stock.

Best- and Worst-Performing CEF Categories Commodities weren't the only disappointing sector last month; few categories performed well. And the two best-performing categories are small. There's only one market-neutral CEF--Eaton Vance Tax-Advantaged Bond & Option EXD--and two CEFs in the India equity category--India Fund Income IFN and MS India Investment IIF. India's stock market has been on a tear this year, with the S&P Bombay Stock Exchange SENSEX Index gaining more than 25% for the year to date through September. Interestingly, investors bid up the share prices of the India equity funds despite flat net asset value performance over the month. The table below highlights the best- and worst-performing categories for September.

Discount Trends CEF discounts continued to converge in September. For each of the broad categories, the average discount was about 8% at month-end versus 8% for equity CEFs, about 7% for taxable-bond and muni CEFs, and more than 9% for "other" CEFs at the start of the year. Historically, equity funds sell at wider discounts because of the lower distribution rates compared with bond funds. But the large and persistent disparity of high premiums of bond funds and wide discounts of equity funds following the crisis was unusual. That trend seems to be normalizing, though the average discount of bond funds is wider than it's historically been.

Source: Morningstar

As the bond market has slowed and the Federal Reserve inches closer to raising interest rates, taxable-bond CEFs look less attractive from a long-term investment standpoint than during the bull market of 2009 and 2010. For equities, after dipping to double-digit discounts in the aftermath of the 2008 financial crisis, those funds' discounts were slow to narrow, though continued economic improvement has helped.

Most Expensive and Inexpensive CEFs The middling performance of both bonds and stocks last month didn't create many attractive valuation opportunities. The four tables below list the five most inexpensive and expensive CEFs by broad category (taxable bond, equity, municipal, and other). The z-statistic measures how many standard deviations a fund's discount/premium is from its three-year average discount/premium. For instance, in these tables, a fund with a z-score of negative 2 would be two standard deviations below its three-year average discount/premium. Funds with the lowest z-scores are classified as Relatively Inexpensive, while those with the highest z-scores are Relatively Expensive. We consider funds with a z-score of negative 2 or lower to be "statistically undervalued" and those with a z-score of 2 or higher to be "statistically overvalued." That said, the z-statistic does have its flaws.

Cara Esser is a closed-end fund analyst at Morningstar.

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