Our allocation within the CEF space is guided by the following considerations.
- sectors and funds where discounts look too wide relative to history – occasionally, these sectors deserve to trade at relatively wide discounts (vs. the sector or relative to their own history), however, this is not always the case. Telling the difference between the two cases can provide a keys source of additional return.
- sub-sectors where underlying valuations (i.e. credit spreads) have some more room to compress towards pre-drawdown levels. These also vary – over the past couple of years these sector have included high-yield / unrated munis, dollar-denominated Emerging Market government / corporate debt, mezz CLO Debt, non-agency RMBS and other sectors.
- sectors with some reflationary upside via an equity-link e.g. convertible debt. These funds can strongly outperform traditional fixed-income funds, particularly, in a rising rate environment.
- term CEFs which can deliver both discount stability, relatively low duration and an additional return tailwind from discount compression.
- specific alpha opportunities, based on attractive valuations, managed distribution policy distribution changes, fund mergers or other special situations.
- funds which have an unusually broad credit mandate e.g. ARDC, DCF and can move across different geographic regions and credit assets for opportunities which can deliver outsized alpha.
- relative-value CEF rotation strategies, particularly across funds of the same issuer which often have nearly identical holdings but can trade at very different discounts – time is of the essence here as mispricings tend to be snapped up.
- CEFs with a margin-of-safety such as funds with activist backing, funds having repurchase programs in place, funds with a formulaic managed distribution policy and others.
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