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Japan Equity CEFs Win the First Quarter

These closed-end funds were unstoppable in early 2015; plus, did the first IPO of 2015 usher in a new era for CEF shareholders?

Jason Kephart, 04/16/2015

The Federal Reserve's quantitative-easing program was highly correlated with strong returns in the U.S. stock market in recent years. With a similar program under way in Japan, investors are heavily betting that the international sequel will be just as good as the original.

Japan stock was the best-performing closed-end fund Morningstar Category in the first quarter in both share price and net asset value. The two CEFs in the category take different approaches: Aberdeen Japan Equity JEQ focuses on larger-capitalization names while Japan Smaller Capitalization JOF focuses on small-cap stocks. Japanese equities of all sizes were boosted in the first quarter as the government continued its quantitative-easing efforts. Aberdeen Japan Equity gained 19% in share price and 15% in NAV in the first quarter, and Japan Smaller Capitalization gained just under 11% in both share price and NAV. The table below shows the top-performing categories for the first quarter ranked by share-price return.

One thing that benefited the Japan stock funds was a more stable yen. The depreciation of the yen has been one of the hallmarks of the quantitative easing in Japan. It has depreciated against the dollar by roughly 20% since the program was announced in late 2013 but was largely unchanged during the first quarter. How a fund manages its currency exposure can have a big impact on returns. Both Aberdeen Japan Equity and Japan Smaller Capitalization have some flexibility to hedge currencies, but neither had a significant hedge on as of their most recent portfolios, dated Feb. 28, 2015, and Nov. 30, 2014, respectively. Going forward, the attractiveness of both CEFs could hinge as much on currency movements as stock prices.

There's been a significant dispersion between local-currency-hedged Japanese equity funds and non-currency-hedged funds during the past few years. The exhibit below shows the difference in the growth of $10,000 between two exchange-traded funds: the unhedged iShares MSCI Japan EWJ and WisdomTree Japan Hedged Equity DXJ since 2013.

Source: Morningstar.

A New Era for CEF IPOs?
Calamos Dynamic Convertible and Income CCD raised $555 million in the first CEF initial public offering of the year on March 26. During the past year, many CEFs have been trading at wider discounts than usual. Municipal CEFs, for example, had an average discount of 5.76% at the end of the first quarter in 2015, considerably wider than their three-year average of 2.75%. The wider-than-usual discounts have made the IPO market dry up considerably. There were only 11 IPOs in 2014, after 24 in both 2013 and 2012.

Calamos' offering is unique, though. Instead of simply letting the market forces determine the share price relative to the fund's NAV, the fund implicitly stated that the advisor would step in if shares trade at a discount of more than 2% and purchase up to $20 million worth of shares to bring the price closer to NAV. It's essentially the first CEF warranty program.

is an analyst covering alternative strategies on Morningstar’s manager research team.

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