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By Mike Taggart, CFA | 06-13-2013 01:00 PM

Reasons for Excitement for CEF Investors

The current environment is positive for CEF investors as more attractive discounts are coming to the surface, particularly with fixed-income vehicles, says RiverNorth's Patrick Galley.

Mike Taggart: Hi, I'm Mike Taggart, head of U.S. closed-end fund research at Morningstar. Investing in closed-end funds can be a rewarding, if complex, endeavor. As an institutional portfolio manager, Patrick Galley of RiverNorth Capital knows how to navigate the complexities of closed-end fund investing better than most. Patrick oversees $800 million of closed-end funds, and I'm happy to have him here with me today at Morningstars' Investment Conference.

Patrick, thanks for joining me.

Patrick Galley: Thanks for having me, Mike.

Taggart: Patrick, the question on probably every closed-end fund investor's mind right now is what's going on with the discounts. Obviously it's related to Fed chairman Ben Bernanke's comments in May about tapering the quantitative easing. Discounts have widened out significantly. What's your take on closed-end funds in this environment?

Galley: Closed-end funds are probably one of the best sentiment indicators out there because of the discount and premium associated with them. When there is greed in the marketplace, discounts are narrow. CEFs even trade at premiums; that's the environment we were in [in May]. [In mid-June] it's gone to fear, and discounts, specifically on the fixed-income side of the equation, have widened out quite drastically in the tune of 5% to 10% in some cases in just a short two weeks. We really think it's a fear-driven trade, meaning that fixed-income investors that were invested for yield only are now pushing out discounts as they sell their fixed-income closed-end funds and then lock in gains, which they actually still have from a total-return perspective.

Taggart: Do you think it's overdone? What's your outlook for what happens to closed-end funds, a year down the line as interest rates rise?

Galley: I think if you're looking at the discount, it's overdone because the discounts are that sentiment gauge. These are discounts that we haven't seen for quite some time. We are still in a world of low short-term rates, and we think that's pretty darn attractive for closed-end funds because if the Fed starts loosening the quantitative easing, it's the long end of the curve that's going to rise, which means we have a steepening of the yield curve. That's a positive environment for the closed-end fund space. You have more attractive discounts today, and you have a better carry trade for the closed-end funds on the fixed-income side.

Taggart: It sounds like you're pretty bullish?

Galley: We're excited about the environment we're in today.

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