I can give you a name of a fund trading with the equivalent of a 23% sales charge. It’s actively managed by a company that’s incurred large outflows from its signature mutual fund following the departure of its star chief investment officer. Interested in owning it?
You probably aren’t, but some investors were. PIMCO’s Municipal Income Fund (PMF) , a closed-end fund, traded at a 23.4% premium to the underlying value of its net assets last Friday. Put another way, some investors were paying $1.23 for $1.00 worth of net assets. One doesn’t have to know much about investing to realize this isn’t smart.
PIMCO Municipal Income Fund wasn’t the only offender. Eight other closed-end muni bonds funds ended last week with premiums of 10% or more. In comparison, the average closed-end bond fund traded at a 2.32% discount (meaning investors paid just under $0.98 for every dollar of assets), according to the Closed-End Fund Association (CEFA). The average stock closed-end fund traded at a 7.49% discount.
For those of you who are curious, here are the highly priced bond funds, sorted in descending order by their premium based on data for last Friday (July 8) from the CEFA:
- PIMCO Muni Income (PMF), 23.40% premium
- PIMCO NY Muni Income II (PNI), 21.62% premium
- PIMCO CA Muni Income III (PZC), 16.78% premium
- BlackRock VA Muni Bd Tr (BHV), 15.27% premium
- Pimco CA Muni Income II (PCK), 15.27% premium
- BlackRock MuniYld AZ (MZA), 14.71% premium
- PIMCO CA Muni Income (PCQ), 12.52% premium
- BlackRock MuniVest II (MVT), 11.97% premium
- PIMCO NY Muni Income (PNF), 10.59% premium
The premiums on several of the funds have come down since last Friday, but still remain high. As of yesterday, PIMCO Muni Income trades at an 18.89% premium.
Closed-end funds differ from mutual funds and exchange-traded funds (ETFs) by having a fixed number of shares. As money flows into and out of mutual funds and exchange-traded funds, the number of outstanding shares is adjusted. Mutual funds directly issue shares to and redeem shares from shareholders. ETFs adjust their share counts through creation units, which are large blocks of shares issued to and redeemed from institutional investors and large traders. If there are more investment dollars flowing into a closed-end fund than the net value of its assets, shares of the fund will trade at a premium to their net asset value (NAV). It’s the law of supply and demand. More dollars will drive up the share price because transaction proceeds go into the pockets of selling shareholders, but never into the closed-end fund. (New investor dollars only flow into a closed-end fund when an offering occurs, which is not very often.)
This fact invokes the greater fool theory. When a premium, particularly a high premium, is paid, the investor is hoping there is someone willing to pay an even higher price for the same shares. Two events could cause this investor to incur a loss. The first is the fund’s net asset value declining, which should cause the share price to decline and is an inherent risk with any type of fund. The second is a decrease in the premium. Should the premium decline faster than the fund appreciates in value, the investor could lose even though the underlying net asset value of the shares increased in price. The worse-case scenario, of course, is for the fund’s NAV to decline and its premium to shrink—a double whammy.
How do you avoid such a scenario? Check the Closed-End Fund Association’s website. They list a closed-end fund's premium or discount right on the quote page. I also find their screener to be very helpful. (Click on "fund selector" near the top of any page.) You can screen by type of fund as well as by other characteristics, such as premium and discount.
The Week Ahead
The earnings calendar will be dominated by mega-cap companies. In total, more than 90 members of the S&P 500 are scheduled to report. Included in this group are 10 Dow components: International Business Machine (IBM) on Monday; Goldman Sachs Group (GS), Johnson & Johnson (JNJ), Microsoft Corp. (MSFT) and UnitedHealth Group (UNH) on Tuesday; American Express (AXP) and Intel Corp. (INTC) on Wednesday; Travelers Companies (TRV) and Visa (V) on Thursday; and General Electric (GE) on Friday.
The week’s first financial reports will be the July housing market index, released on Monday. Tuesday will feature June housing starts. The July Philadelphia Federal Reserve’s business outlook survey and June existing home sales will be released on Thursday. Friday will feature the release of the July purchasing managers’ manufacturing index (PMI) flash.
The Treasury Department will auction $13 billion of 10-year inflation-indexed securities (TIPS) on Thursday.
About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)
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