Closed-End Fund Valuations Get More Appealing

Scott Burns: Checking in on closed-end fund valuations. Hi there. I'm Scott Burns, director of closed-end funds and ETF research with Morningstar. Joining me today is closed-end funds strategist, Mike Taggart. Mike, thanks for joining me.

Mike Taggart: Thanks for having me.

Burns: Over the past couple of weeks we've seen a general market decline. Then yesterday we had the market crash of 2:45, that is PM Eastern, and then the recovery. With the general trends, what have we seen in the closed-end funds? What was the state of closed-end fund market before yesterday?

Taggart: Just over all of the 621 closed-end funds out there, what we had seen is for the last, say, month they were all trending over towards the overvalued space. Their discounts and premiums were trending higher, in some cases significantly higher on a statistical basis, than their three-year average discounts or premiums. After yesterday, and actually over the course of the last week, we have seen them trend significantly and quickly to the left, back toward a more normal state. But for the first time in a month, we are actually seeing some funds pop up as being statistically significantly undervalued.

Burns: So we managed to go from a state of overvaluation to undervaluation. What do you think is really driving that?

Taggart: I think a lot of it is these discounts and premiums are the share price relative to the net asset value. A lot of times you have investors who are just trying to get out of the market. They are anticipating further downside or further upside or whatnot, and that motivation or that anticipation isn't reflected in the underlying shares of the fund's portfolio. So the net asset value doesn't fall quite as much as the share price does, because of market behavior.

Who can blame people yesterday for hitting the panic sell button? Hopefully, they didn't do that, but in some cases that happens. A lot of times, what you'll see on overseas markets is maybe the local market for overseas closed-end funds the local market might start to stabilize after a sell-off and might even start to come back a little bit, but investors in the U.S. aren't going to jump right back in immediately.

Burns: So that's a function of the NAV going up, but the interest in the fund still remaining pretty dormant.

Taggart: Right, exactly.

Burns: It sounds like we went from a period where it was hard to find opportunities to a period where things are starting to look a little better on the opportunity front in the closed-end fund space?

Taggart: Yes. We like to look at things on a three-year basis right now. We think that investors should take a three-year investment horizon. There are starting to be some opportunities in the space. Not really yet in the fixed-income space, where we think that we're statistically significantly undervalued, but they're coming down, too. I was going to say for current investors, "Yikes!" But it's possible that even there in the next few weeks if things persist like this, that we're going to start seeing some opportunities there as well.

Burns: All right. Thanks for the update. I'm Scott Burns, director of closed-end fund and ETF research with Morningstar. For this and other ETF and closed-end fund news and information, please check out Morningstar.com's ETF and closed-end fund tab.