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By Mike Taggart, CFA | 09-10-2013 10:00 AM

Bond CEFs Only in First Inning of Discount-Volatility Game

Many fixed-income CEF investors are heading for the exits, but the movement is creating attractive discounts, says RiverNorth's Patrick Galley.

Mike Taggart: Hi. I'm Mike Taggart, head of U.S. closed-end fund research at Morningstar. With me today is Patrick Galley of RiverNorth Capital Management. Patrick manages over $800 million in closed-end funds. Patrick, thank you for joining me today.

Patrick Galley: Thanks for having me, Mike.

Taggart: Patrick, the last time we sat down and spoke, it was at the Morningstar Investment Conference back in June, and we shot a video; you were on one of my panels. At that time, we were about a month into the Federal Reserve's tapering talk and interest rates in the market had just started to creep up. Everybody was concerned about what the summer might hold. It's kind of played out. What's happened this past summer?

Galley: Well, obviously, interest rates continued their trend up and touching 3% on the 10-year Treasury, I think, is definitely a milestone for a lot of investors in their heads, from a psychological standpoint. So that fear is still going through the closed-end fund market. Discounts on fixed-income closed-end funds specifically have widened and continue to widen. I think that it's only probably the first inning of future volatility in discounts of fixed-income closed-end funds.

Taggart: Now, the one thing I try to remind investors through my articles and when I speak with them is, a discount or a premium is simply the relationship between the share price and the net asset value. So when you say discounts have widened, what you're really saying is that the share price has fallen considerably faster than the net asset value, and the net asset value is made up of a diversified basket of funds. So, it goes back to what I see a lot with closed-end funds, is that the investors in closed-end funds, when they want to get out, they race to the exits. They don't care how many shareholders are clogging those exits. And when they are selling their shares, they are selling them to folks like yourself, who are opportunistic and look for the discounts to widen.

Galley: Yeah, exactly. At RiverNorth, we're opportunistic investors, we're total return investors. So a lot of times closed-end fund investors are focused on the yield. So, just a short few months ago and over the past couple of years, in fact, investors were focused on that yield and yield only. Today, because yield is inversely correlated with interest rates and fear is going through the marketplace because interest rates are rising, now investors can only think of one thing, that's to get out. It's like screaming fire in a crowded theater and everybody is running for the door. There aren't enough buyers. So the supply/demand dynamic in a closed-end fund means, guess what, the discount is going to be widening out. So, RiverNorth is buying--we're buying those closed-end funds at attractive discounts to net asset value.

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