What’s the Deal With Equity CEF Discounts?

We like to track both top-down and bottom-up CEF metrics to find both major trends as well as individual opportunities across the market. In particular, we like looking at sector discount trends. One such trend that has recently become clear is the weakness in Equity-linked sector CEF discounts which are shown in the chart below from our CEF Tool. We can see that a number of these sectors are trading at discounts close to or wider than what we have seen over the last decade.

This is plainly odd – CEF discounts tend to be procyclical, in the sense that they tend to mimic moves in the underlying asset prices. When asset prices are strong discounts tend to tighten and vice-versa. So what we are seeing now is the opposite – stock prices have done very well since the March drawdown but discounts have only moved wider.

What could explain this?

Part of this could be investors taking some chips off the table, banking gains in expectation of additional volatility. The recent rise in the VIX and other hedge instruments echo this dynamic as well.

Investors may also be reconsidering their overall portfolios – finally bailing out of CEFs that delivered such enormous volatility and drawdowns. No doubt, some are moving to lower-volatility options such as open-end funds.

Other funds may be going through tax-loss harvesting. Apart from convertibles, the other equity-linked sectors are in the red in terms of year-on-year price returns.

Overall, this opening up opportunities in the space.