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By Jeremy Glaser and Cara Esser | 04-02-2013 01:00 PM

MLP Closed-End Funds Gain Energy

CEFs that focus on master limited partnerships performed exceedingly well in the first quarter, yet there are still large discounts among equity closed-end funds, says Morningstar's Cara Esser.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Cara Esser. She's a closed-end fund analyst. With the first quarter behind us, we're going to take a look at the state of the CEF industry. Cara, thanks for joining me.

Cara Esser: Thanks for having me.

Glaser: So let's start just a little bit about IPOs, new funds that we saw this quarter. Anything interesting on that front?

Esser: Yeah, well, we had five IPOs at the start of this year, which is about on par with what we had the last two years in the first quarter. So nothing too exciting, but we did have the biggest IPO that we've seen since 2007, and that was from PIMCO. It was another go-anywhere fixed-income fund. After they had success with a fund that they launched last year, they launched another one, PIMCO Dynamic Credit Income, this year at the end of January. And it raised about $3 billion.

Glaser: Now, how about performance? How have various categories have been performing? Any standouts there?

Esser: Yeah. So, on the performance front we saw a lot of the sector funds performing incredibly well. So a lot of the equity energy funds, master limited partnerships in particular, performed exceedingly well. The health-care funds performed pretty well, and also Japanese equity funds performed well. On the negative side, we saw some commodities and precious metals funds not do all that well, and also some communication sector funds performed fairly poorly over the quarter.

Glaser: Any individual ones kind of stand out to you?

Esser: On the equity energy front we had the top five fund performers for the entire universe for the first quarter, the five MLP funds, and each of them gained about 25% just in the first quarter. So it's a pretty big jump, and these funds actually performed worse at the end of last year. So we’re just seeing a bounce-back a little bit there, but we've seen a lot of interest in these energy funds.

On the poor-performing side, a serial underperformer, back again on this list is ASA Gold and Precious Metals fund. It was on the worst-performing list at the end of last year and it continues to be a poor performer this year.

Glaser: One of the reasons investors have been looking at MLPs for those distributions is for that income, and then closed-end funds more generally. Did we see any big change on the distribution front, any big increases, any big cuts, or things to be aware of?

Esser: We didn’t see anything too dramatic on the distribution front. We did see a continuation of a trend of more discount reductions than we saw increases by about 2-to-1. The average fund decreased its distribution by 7.5%. That would a fund that did decrease its distribution; the average distribution cut was about 7.5%. So nothing dramatic, but we are seeing funds continue to pare back on distribution payout.

Glaser: What's driving that?

Esser: I think the market in general is driving that. There is a lot of fixed-income funds in the closed-end space, and yields are just low everywhere. So, they can only pay out what they get. It’s hard to find yield, and they haven’t been able to do it for a long time.

Glaser: How about discounts and premiums, any big changes there?

Esser: We actually have seen shift a little bit in some of the discounts and premiums. We had seen a lot of closed-end funds that invest in bonds, especially municipal funds, see an increase in premium over the last few years, and we've seen a lot of the equity funds increase the discounts over the last few years. But we saw a reversal in that so far this year because the equity market has done pretty well. So the average equity fund is selling at about a 1% discount, which is much narrower than it was at the end of 2012. The average municipal fund is selling at a 1% premium, which still sounds pretty high, but it's actually much narrower than it was at the end of the year. The average taxable fixed-income fund is selling at a wider discount than it was at the end of the year.

Glaser: So, at the end of this quarter, do you see any big opportunities, any funds that you think look like they could be attractive right now?

Esser: Despite the fact that we see the narrowing of the discounts in the equity space, there are still a lot of very large discounts in the equity space. Investors had been ignoring those funds for some time, and the market’s coming back. And it might be a good time to check out some of those funds; a lot of them are selling at double-digit discounts still.

Glaser: Cara, thanks for talking with me today.

Esser: Thanks for having me.

Glaser: For Morningstar, I’m Jeremy Glaser.

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