April is in the books, and the markets continued their upward climb after March’s mild and short-lived sell off. Aside from temporary fluctuations, closed-end funds measured by the RiverNorth Closed-End Fund Index have consistently turned in positive performance, returning more than 25% since last June.
Looking ahead, several events loom on the horizon: the end of QE2, continued Middle East turmoil, inflation fears, rising energy costs, concerns about interest rates and the ongoing effects of the disasters in Japan. While the worldwide economic repercussions of these events remain to be seen, their effects on closed-end funds should be watched and could present attractive investment opportunities.
Rising short-term interest rates is a risk calling for extra attention from closed-end fund investors. The capital structure of closed-end funds is directly affected by changes in short-term interest rates, as closed-end funds often use leverage to enhance the returns and yield of their portfolios. Approximately 73% of closed-end funds currently utilize some form of leverage.
The cost of the leverage is often floating based off short term interest rates and if rates rise, the cost of leverage increases and drags on performance.While the Fed has clearly stated it intends to keep interest rates low for an “extended period,” closed-end fund investors should be aware of the impact of short-term interest rate changes.
Before the Fed last began to raise rates, on June 30, 2004, taxable fixed-income closed-end fund discounts widened out 9.25% in just over a month. Anticipation of rising interest rates was a primary driver of the drastic discount widening seen in 2004. No one knows exactly when the Fed will choose to raise rates, but the prospect of rising rates is garnering a significant number of headlines and presents a risk worth monitoring.
April Closed-End Fund Sector Roundup: Real Estate a Leader, Non-U.S. Equity a Laggard