The shock of Britain’s vote to leave the European Union had asset management analysts scrambling to determine the impact on various fund offerings.
One of the immediate opportunities in the wake of the decision for investors were above average discounts in a range of closed-end funds.
The event “has pushed yields even lower, and as yields go lower, obviously that’s good for people that are holding bonds — but for people going forward it means there are going to be lower returns,” says Mike Boyle, EVP and head of asset management at Advisors Asset Management.
Speaking with Money Management Executive, Boyle addresses Brexit, the continuing low interest environment, and the challenges in persuading clients to diversify and increase risk.
How has the closed-end fund industry been affected by the U.K.’s vote to leave the European Union?
First and foremost, the vote was obviously touch-and-go. Our guess was that it was going to be a bit of a speedbump, and I think we saw that. The market rallied right before the vote, we then sold off, and now believe it or not we are at new record highs. We eclipsed the May 2015 highs and it took us about 14 months, which I think is surprising.
It also sends a message to a lot of people that this is not going to be the end of Britain, it’s not going to be the end of Europe, and it’s not going to be the end of global expansion; but it’s definitely a speedbump.
What it has done is it has pushed yields even lower, and as yields go lower — obviously that’s good for people that are holding bonds — but for people going forward it means there are going to be lower returns.
Closed-end funds is a space that historically allowed investors to, one, usually buy assets cheaply at discounts, but it also allows investors to go after — through the prudent use of leverage — things with slightly higher yields. We have been talking about, for quite some time, negative yields across the board.
The U.S. has obviously not participated in that, but about two weeks post-Brexit we basically hit all-time lows in yields across the board, whether it was corporates, whether it was government bonds or whether it’s munis, you are going to have people — especially the baby boomers, as an example — hungry for yields and closed-ends have traditionally been a place for investors to buy discounted assets with higher yields.
I think given the yield spectrum that’s come out post-Brexit, it’s going to make closed-end funds even more attractive.
What kind of impact does the potential for additional interest rate hikes have on this space?
We have been a firm believer, at least in the U.S., that the trend should be higher yields, but we always sell even before the Brexit vote came about.
In the wake of Brexit we have gone down and touched all-time lows, even lower than we saw back in May 2013, right before the taper tantrum occurred when Ben Bernanke threw out a head fake and everybody thought rates were going up and we saw a big spike from May 2013 through the fall — and then to the end of the year of about 170 basis points from 1.3% on the 10-year.
I think now, clearly globally the trend for rates is going to be, if anything, lower in the U.S. because everything is so connected now with globalization. I think the chance of rates moving up quickly in the U.S. is probably pretty rare. The odds don’t go about 50% that they’re going to raise again here in the U.S. until March, based on my last inspection.
We got so low here that we probably need to move up again. I think we got as low as about 135 [basis points], as of today we are at around 155, and we’re talking about the 10-year.
The U.S. probably needs to move up a little, but given that everything is so interconnected, and is somewhat fragile, we don’t know for sure how Brexit is going to affect global growth, European Growth, etc. Obviously they’re going to err to the lower. I think the biggest fear right now, or risk for investors, is if you invest today in a 10-year, you’re looking at 1.55% as the current yield. Inflation just came in at 1% and you’re looking now at a real return of 55 basis points. That’s probably just not enough.
We don’t think rates are going to the moon and are going to knock investors down, but we do think those low yields are not going to be appetizing enough and you are going to see investors looking for alternative sources, and one of those is going to be the discounted closed-end funds.
When positioning products in these closed-end funds, how is your firm trying to take advantage of that investor attitude and potential renewed interest?
First, when it comes to closed-end funds we always tell people that we try to make money in three different ways. One; we try to buy closed-ends selling at discounts that are bigger than usual. Two; we want to buy funds that we think the net asset value can appreciate. Three; we want to buy ones that have very, very nice coupons.
As I mentioned earlier, every fixed income asset class is at or near an all-time low in yields, meaning the prices of bonds are at all-time highs — meaning that at least here in the U.S. we’re pretty expensive.
We think as an example, stocks relative to bonds right now are pretty cheap based on yields. For example, the 10-year yields for the S&P are right around 2.1%, so we’re very close to the 10-year average. A lot of that has to do with the fact that dividends in the equity market tend to grow. The average is about 7%.
So, even though stocks are up, we still have that same yield. For one we would be attacking things that we think are relatively cheap compared to other assets and that would be things like dividend-paying stocks and also a covered call type strategy. Secondly, we want to buy those hopefully cheaper than normal. If you look at the traditional discounts on equity dividend closed-end funds, the long-term average for those is right around 5%.
The universe right now is selling closer to 8% and we’re able to put together a portfolio of some of our favorites — probably closer to 12% or 13%.
We want to buy funds that we think are cheaper than where they usually trade. Secondly, we want to buy ones where we think the assets have a good chance of appreciating and we collect those coupons.
Hopefully we can monetize two or three of those, and we think probably people will be able to outpace fixed-income over the next 12 to 24 months.
How long do you think this dip in government bond yields will continue?
If you go all the way back to 2013 when we had that taper tantrum and spiked back up to 3%, we were very adamant and came out at that point and said, “Hey, yields are going to be lower six months from now and even 12 months from now — we think they are going to be low for a very long time.”
As of right now we are sitting at about 155 basis points. The 10-year average for the 10-year bond is about 295 bps, so I think we could be five or six years removed from getting back to those types of levels, even though we hit them right on the end of 2013. We are also starting to get there right about now.
I think for the U.S. [interest rates] are going to stay very low, and the reason is obviously that people are worried about what’s going on globally. The U.S. is still the safe haven, but also the Federal Open Market Committee is going to need to keep rates artificially low because of what’s going on across the pond.
If we use that 3% 10-year average as a level, I think we’re going to be a very long time, four, five or six years, before we see that type of level again.
What kind of pressures does that put on product producers like your firm?
It’s a little more difficult because in addition to having this product, which we would consider an alternative income product, we also do packaged traditional bonds inside of a unit investment trust.
We have investment grade — slightly below investment grade — options, we have muni bonds, and what happens is when yields are this low, if we put together a high quality muni portfolio right now, that yield might be north of 1%.
There may be a point where investors are going to say, “It’s an investment, there’s risk there, but my return potential is just over 1%.” That’s really not enough, but clearly people are still buying bonds because we see the yields are a little low.
So, you have to stress to people that they need to do a little bit of diversification — or a little bit of barbell. Some of the money they did have in the investment grade, or the higher quality where the yields are lower, they may need to step up the risk spectrum a little. But, we’re still seeing a tremendous amount of appetite for that. The yields are just getting to the point where there just won’t be enough there for investors to want to go in.
People have been trying to predict when another interest hike might happen, and any time there seems to an indication that the Fed will raise interest rates, something happens to push back.
Will the events in Europe and now Turkey make government authorities feel less confident?
Absolutely, and I think we’ll use Brexit as an example. A day before the markets were rallying and across the board, people were saying, “This means the boat will sail and everything’s fine.” And then lo and behold, the vote didn’t pass. They were wrong, and those same people were saying, “Run for the hills because now we’re going to have an unwinding.”
Sure enough the market did sell off, we made four record highs last week, and as for the S&P 500, I don’t know how Brexit can be a catalyst, but sure enough it is.
When you take a look at the U.S., obviously there’s violence by police, there’s violence on police, we’ve got what happened in France with the truck in Nice, we had the Turkey event, and we seem to have more and more of these incidents. But, for the most part the market, at least at this point, is shrugging them off.
We have VIX almost at an all-time low a month after we had the Brexit vote, and around 26 days removed, it’s just amazing that we have volatility almost at an all-time low here, or at least close. People seem to be a little bit, at least for the moment, not concerned, which we find concerning.
We think that the equity markets have been a bit stretched. Again, especially for bond investors, we think the trend is going to be up in yields in the U.S. We think it will be somewhat controlled in the move, when it occurs — not a taper tantrum — and probably the biggest factor fixed income investors need to look at right now is: “Are you happy with 1.5%? Are you happy on that level? If you’re not, we think there are some alternatives that you can look at.”