Often overlooked by most investors, Closed End Funds offer attractive returns and a unique wrapper of capital preservation. Joshua Duitz, Gregg Abella, and Ken Nuttall come together to discuss the outlook for dividends, the potential impact of trade tariffs and how the conversation about Closed End Funds can improve.
Sarah: Welcome to Asset TV, I am Sarah Makuta. Often overlooked by most investors, Closed End Funds offer attractive returns and a unique wrapper of capital preservation. Today I am joined by a panel of experts to discuss the outlook for dividends, the potential impact of trade tariffs and how the conversation about Closed End Funds can improve. Welcome to the Closed End Fund Masterclass. Gentlemen, thank you so much for being here today. Alright, well, let’s kick it off with what exactly is a Closed End Fund? Let’s start; I’ll start on this end of the table.
Gregg Abella: Closed End Funds actually have their origin going back to Europe, at least a 100, if not 200 years ago, Aberdeen actually was among the first companies to launch them to invest in the emerging markets, which at that time was the United States. So they are funds that are … the shares are issued once, they go public at a strike price. The assets that are in it are the asset that stay in it. It trades like a stock during the course of the day. But if you redeem your shares it’s to somebody else who is buying them as opposed to an Open End Fund where if you redeem your shares the money actually comes out of an Open End Fund at the end of the day.
Sarah: Excellent. Josh, did you want to add to that?
Joshua Duitz: I do. So, as Gregg mentioned, there’s a fixed number of shares in the Closed End Fund as opposed to an Open End Fund. And one of the things that differentiates the two, between an Open and Closed End Fund is that when the markets are going up and investors start putting money into that Open End Fund, you’re forced as a Portfolio Manager to actually buy more shares. And reverse, when the markets are going down you’re actually forced to sell shares if there’s redemptions, being there’s a fixed pool of capital in the Closed End Fund, you actually are not forced to make any decisions that you might not make otherwise.
Sarah: Excellent. Let’s talk about the different types of Closed End Funds. What’s the difference between a perpetual and a term Closed end Fund?
Ken Nuttall: So, most of the funds out there are perpetual, meaning that there’s no termination type date. But in recent years there have been ones have been developed that come up with the termination date. And the reason for that is that a lot of times these Closed End Funds trade with either discounts or premiums. And that term is really kind of there to kind of close that bridge of the discount or the premium to get it.
Sarah: Okay, excellent. Let’s talk about the current landscape in the Closed End Fund space, give us a little perspective here.
Gregg Abella: Well, Closed End Funds manage roughly $300 billion worth of total assets; I think that figure is about right. And if you put that in the context of assets under management in investment companies, the ETF space has grown from when they had about the same amount of assets in 2005 to north of $3 trillion in ETFs, so 10 times more assets in a short amount of time. And in the Open End space globally there’s about $40 trillion in Open End mutual funds, about half of which is in the Americas.
Sarah: Excellent. What you described about being in the ETF space and what does this all mean really for investors?
Gregg Abella: It can mean a number of things. I think that investors have made choices as to which type of product, and advisors too, have made choices as to what types of products they want to buy on their own behalf or on behalf of their clients. And you have to wonder, and I don’t necessarily believe this but you have to wonder in the scheme of things is a Closed End Fund anachronistic or are there opportunities because of its size relative to the rest of the investment management universe? I personally believe it’s a combination of both. And we’ll talk about, you know, some opportunities I think that exist in Closed End Funds.
Sarah: Definitely. Josh, what are some of the tailwinds and headwinds for this market?
Joshua Duitz: So the market in general, so on certainly the tailwinds, we’ll start with the United States. And we actually are seeing great growth of earnings in the second quarter, it was about 27%. And part of that is tax, obviously tax cut. One of the other things that we notice is that revenues were actually up 11% in the second quarter. So we are still seeing some synchronized global growth and there are some pockets where we’re actually seeing that just slow down a little bit, so there are. And if you look at productivity, that’s higher, retail sales are good. So there are good economic numbers and the leading indicators certain in the US are still good. On the headwind side, well, we all know about tariffs, what’s going on. And tariffs, global trade is so important, and that’s led to the synchronized growth. So if we actually see tariffs being put in place, it’s going to be a huge problem I think, long term. Short term, I don’t think it’s really there yet. So hopefully we do have a compromise, so that’s one. Just going back to the tailwinds, certainly central banks are still very friendly. But we are starting to see The Fed raise interest rates and that could happen globally. I think one of the headwinds for me long term is just the amount of debt that governments have on their balance sheets, that scares me, when we look in the US we’ve gone from 10 to 20 trillion dollars. We’re now, you know, one times GDP, so that scares me. And that’s happening globally, in Europe and Japan. So there are a lot of puts and takes to it on the market. And certainly as a manager we try to understand the risks and then make our investment decisions by understanding all the risks out there. We’re not trying to predict the risks, but really trying to pick companies that could perform.
Gregg Abella: Do you mind if I jump on in this, because I think Josh brings up a very good point. If you have a long view, because of the valuation difference between emerging markets right now and traditional developed markets, we think over the long term it may be a good time, at least to average into emerging markets, maybe you don’t have to go full bore. But traditionally as developed markets get towards the end of a bull cycle, emerging markets start their, I wouldn’t say run, but it starts percolating. We haven’t had that because of all these headwinds that you’ve mentioned. But it may be time, not for everyone, but.
Joshua Duitz: And to add to Gregg’s point, it’s not only emerging markets, when you look at the US versus international markets outside of the US, if you look at the valuations disparity, the US it’s much more expensive on a PE ratio and a price to book, and not only it’s more expensive, but if you look historically where it’s been, it’s one of the widest gaps that we’ve seen. So everyone’s looking at the US because it’s outperformed here in the past 4 to 5 years, and the past 7 out of 10 years. But if you look at that, prior to that, prior 20 years it was evenly split between the US and international markets. So there will be some mean reversion both on price to book, both on PE, including PE as well as performance. So we think now could be a very good time to invest globally.
Sarah: Excellent. And what is your outlook for emerging markets?
Joshua Duitz: It’s interesting, when you ask for the outlook for emerging markets because people view emerging markets as all the same and one asset. But each market’s really different, Brazil’s different than China, and there’s different drivers in Indonesia and Mexico. So we don’t like to look at it as emerging markets. And the nice thing about being an active Portfolio Manager is when something like this is going on, when emerging markets are all getting hit, partly because of fund flows, you could try to really take advantage of the disparity between the different emerging markets and really find companies that could outperform and are getting hit only because it’s part of the EM network. So over the long term though, just going back to emerging markets, right, we’re very positive on emerging markets. And if you look at population growth, that’s one of the reasons why 97% of the population growth over the next 35 years is supposed to come from developing markets, so we think that’s a big opportunity, the middle class is growing there. If you look at even the GDP in China and India versus the US and where it’s been and where it’s growing, you know, there it’s 6/7%. And everyone’s happy when it were 2½%. So we do think there’s big opportunities in emerging markets long term, and you just have to be patient.
Gregg Abella: It can create client consternation though when you see…
Joshua Duitz: Without a doubt.
Gregg Abella: Whether it’s the FANG stocks or whether it’s growth versus value and it’s just one more thing if you have a diversified model to explain as to, well, this asset class hasn’t worked relative to large cap growth in the US, so why am I in it, you know?
Joshua Duitz: And that’s opportunity, right, that’s opportunity because people are selling it.
Ken Nuttall: 101, right, just keep your apples in a bunch of different baskets here and hope, you know, some of them grow and that’s…
Sarah: Well, following up with you, looking for proper exposure across comparable Closed End Fund, what are some consideration?
Ken Nuttall: When we take a look at funds we kind of look at, you know, we kind of group Closed End Funds with the Open Ends and ETFs to kind of see it. So we kind of look at it from a top down look. Like we diversify and try to keep our clients in many different asset pools. So we’ll say, “You know what, 20% of this asset needs to be in developed market, do want to go into developed markets?” And say, “You know what, what’s out there?” And we’ll look at ETFs, we’ll look at the Open End Funds and we’ll look at the Closed End Funds. And we’ll look at the manager; see what they’re doing, seeing what they’re purchasing, seeing what their process is and if it continues to work. You look at the costs, how expensive are these. One of the benefits that Closed End Funds has is that they can actually add leverage to your product. So if it’s an asset where you think it’s going to be going up, the leverage can obviously help you, obviously if the market goes down it goes against you. And then you just kind of look at it and, you know, you look at what the discounts are there, if you have a comparable Closed End Fund with an Open End Fund, but the Closed End Fund is being managed very comparatively because a lot of managers have very similar processes in both their Open Ends and their Closed Ends, but you can get a better yield or some better process in a Closed End Fund, that’s when you purchase that.
Sarah: Got it. Yeah.
Gregg Abella: Ken hit on a very good point, which is that when you’re building your model you have to take into account, is this an asset class that I think over the course of the year, for example, is going to appreciate or is it going to be something like, if you have a portfolio of long dated investment grade bonds with leverage in a rising rate environment, that could be in some ways riskier than a short duration high yield fund with no leverage. So you have to take that into account when you build your model, I may have to put a 0% on long dated bonds particularly, and obviously no exposure to leverage in that asset class. But if rates stop rising, if The Fed signals that it’s done, it may be time to look at some of those funds that have long dated bonds with leverage.
Sarah: Excellent. And what are some of the benefits of Closed End Funds?
Greg Abella: Well, we generally use them in strategies that produce income. And a lot of our clients who are pre retirees or retirees obviously need income and it is in short supply. So we use them tactically, there are opportunities when they trade at big discounts, if it’s an asset class you like, and it’s been out of favor and discounts widen, it’s … you can purchase them opportunistically as a value buyer like we are. And they’re good for diversification purposes, and it’s a great way to diversify a client’s portfolio without having to use, as Josh mentioned, you don’t have to be in a fund that may have to liquidate its very positions because of redemptions.
Sarah: Okay. Benefits?
Joshua Duitz: So I mentioned some of the benefits earlier. One other benefit as a Portfolio Manager, when I look at one of the funds that I manage, AOD, we pay a consistent dividend every single month, right. And while I’m trying to achieve that dividend, I know the exact amount of assets that I have in the fund rather than if it’s an Open End Fund and it’s fluctuating, I’m not sure how much income I have to earn to pay out to the shareholders. So as a Portfolio Manager that to me is another benefit of it.
Sarah: Excellent. Do you want to add any benefits that we missed?
Ken Nuttall: Yeah. I mean the other benefit we kind of like for it is that if you have some more illiquid type of assets, Closed End Fund makes a lot more sense because they’re not going to get sold or a fore sell on that. So if you’ve got someone who’s got some mortgage backed securities or something like that, that doesn’t trade as often, it’s a good place to kind of park them and let them sit.
Sarah: Excellent. Gregg, I know you mentioned ETFs, let’s talk about Closed End Funds and ETFs. Talk about the different wrappers today to employ a diverse investment strategy.
Gregg Abella: Well, we build models, we have individual companies that we pick generally for a large enough portfolio that are in the areas we know a lot about, which is, you know, large cap value is a sign of a real house. But there, you can’t build a portfolio of just large cap value because clients want to have a diversified portfolio, so we use models, we’ll put weightings on different asset classes and then use a combination of ETFs, Open End Funds, Closed End Funds. In something where we think that alpha is not necessarily created by active management we use an ETF. If we can prove or we think we can prove to ourselves that somebody who is an active manager can provide value or alpha to a portfolio, we’ll use either a CEF or an Open End. And we’re fortunate to have relationships with some large bolt to bracket type firms that help us test our own models. And they provide us also with forward looking projections of different asset classes and what the standard deviation of risk is by asset class.
Sarah: Okay. Why and how should an advisor or an investor who is looking to diversify, consider a mutual fund, a Closed End Fund an ETF, can you tell me the reasons there?
Greg Abella: Why should they consider using one versus the other?
Greg Abella: Well, my advice would be, no, don’t try it at home, hire me.
Sarah: It’s a good answer, yeah.
Greg Abella: Yeah. So you have to do your due diligence obviously. ETFs make it a little easier because if you’re just buying an index your due diligence is maybe less so. In a Closed End you have to take into account if it’s an income oriented one, am I getting back my own principal as part of the distribution? Are they employing leverage in an asset class that I don’t think is going to do very well in the short term? Is the governance there? Are you dealing with a manager that doesn’t have conflicts of interest, versus you as a shareholder? Are you basically, are you playing fair? So that’s something you have to consider, Aberdeen are considered one of the good guys out there, not everyone is in that space, like any industry there are outliers. So you have to use your due diligence, the same with an Open End.
Sarah: Okay, excellent. Ken, that same question to you.
Ken Nuttall: Yeah. I mean we kind of think of Open Ends, ETFs and Closed End Funds kind of as like the tools that are out there and we want to use whatever the best tool is to do it. So one of the things we’ve been looking at recently is in like a municipal market for Closed End Funds and stuff. We have a lot of; being here in New York we have a lot of clients who are going to pay taxes, and they want the tax free income. And municipal bonds have kind of, you know, and a Closed End Fund has kind of blown out, they used to have like a 5% discount, some of them are going to be between 12 and 15%. And you sit down and say, “Is that something to invest in, something to put this client into?” But you’ve got to sit back and look at everything else. I mean what does the tax cut really mean here? And some of these Closed End Funds are actually buying longer dated bonds. So you have the whole interest rate duration risk that has, you know, a concept there. But, you know, something, you know, we have a lot of clients who discuss it. And if you’re there for long enough and can take that type of risk or understand that type of risk, I think you’re going to get paid off on that type of stuff. But the thing with Closed End Funds to also think about is that, you know, the discounts do widen, there’s nothing stopping it from widening even more. So it’s always the risk that you have out there to use particular investments.
Sarah: Josh, coming to you, some of the advantages of choosing a Closed End Fund instead of using an Open Fund or an ETF.
Joshua Duitz: I think they said a lot of it but I will say you really can try to take advantage of the fact that there are wide discounts and that it is an underinvested asset class. You know, you mentioned the growth between ETFs and Closed End Funds. And I think that people view it as a whole asset class, Closed End Funds. But you actually get under the hood and you can see the difference in the funds and the managers. And by then grouping it all together you can actually try to take advantage of managers who have outperformed over time.
Sarah: Excellent. You mentioned that the conversation can be improved upon for Closed End Funds, how and through what channels can that be improved upon?
Gregg Abella: I think that Closed End Funds were designed the way they were because that was the technology of the day. That was the best you could do to create a fund, issue shares once, that’s it, strike an NAV, but who cares, because the value where it trades is where it trades. And as we’ve gone along and there was the advent of Open End Funds and they took off. And ETFs have just improved upon liquidity and trading without discounts. So the things that could be improved upon I think, and Josh, I want your opinion on this because when funds trade closer to NAV and management companies take steps to try to close gaps, maybe there’s a way to increase their share count, increase the size of the fund by issuing stock, without having to go to brokers as they have in the past, and issuing stock at say $25 a share but paying a dollar of commission. And therefore you’re starting with $24 of NAV and then it trades at a discount. That’s, as I was saying, that’s anachronistic, I don’t think people really want that anymore. What, I think could be done is you do the money offering without commission from the management company itself, increase the size of the fund when it trades at NAV and take steps to push the discounts to NAV closer to the share price. And I think that would be one thing.
Another thing is, but I think the management companies could do a better job when their counterparts that are selling ETFs and Open End Funds is go out to the advisors and talk about how their strategies fit into their models. We’ve never seen a Closed End Fund company come out, to my knowledge, and say, “Here’s how we think this Closed End Fund fits into this asset class and you should buy it for your clients and here are the reasons why.” It’s at least rare if ever, and advisors are by their nature, I won’t call them lazy, but they may be busy. And they don’t tend to go and visit a manager, they are visited. So it would be great if Closed End Fund managers came out and spoke directly to advisors.
Sarah: Do you want to respond to his invite to criticize that?
Joshua Duitz: I’m always happy to come out, I’ve been waiting for the invitation from many of your clients. But I do happen to agree, I do think it’s a job as Fund Managers, the Aberdeens of the world to actually go out. And we are actually trying to do that more and more often, to not only explain what the funds do and let them know who the managers are, look at the track records and actually look under the hood and see what funds are actually useful to your clients. So hopefully that will happen. And I happen to agree, I think the first step is going out there, reintroducing the funds to that investor base and after you do that and then hopefully you trade closer to NAV, one, you make money because of the Closed End discount and hopefully you perform well also in that combination. And then the next step would definitely, you would hopefully be able to issue more shares at some point.
Sarah: Excellent. Ken, suggestions for improvement?
Ken Nuttall: I guess the biggest thing is that a lot of times I’ll have a conversation with a client and I say, “I’m going to put you into this fund, it’s a Closed End Fund.” They’re like, “What is that, is that brand new?” And I’ll tell them like, “No, this fund’s actually been around forever and a day.” I mean it’s just ETFs have done a very good job of explaining what they are, the Vanguards and the BlackRocks of the world, everyone knows what those are. The Open End mutual funds have done a great job, Closed End Funds are a little bit sleepier, which sometimes have vanished because like, you know, these funds, you know, they’re getting professional management just like the other Open Ended Funds, but you’re getting usually a discount or, you know, some leverage, you can take advantage of that kind of stuff.
Gregg Abella: I think operationally also the Closed Ends could be more communicative to the custodians so that when they distribute out, capital gains or return of capital, that it actually decrements your cost basis. Because you could hold a Closed End Fund for a very long time, have had a positive return and on your statement it might show your cost base is at $10,000 and your market value at $8,000 because the cost basis has never been decremented down. So I think they could do a better job of that for optics.
Sarah: Excellent. Yeah, Gregg, you also wanted to talk about tax reporting.
Gregg Abella: That’s a whole other ball act. Sometimes funds trade at perpetual discounts because they’ve had positions for a very long period of time with low cost basis. And at some point if they ever sell, that is going to be your tax bill. So nobody wants to buy a tax problem. So those funds tend to trade at large discounts to asset value. That’s something that I think the structure just, it’s the nature of the beast. I’m not sure what can be really done on that score. But it is something to consider when you’re doing your due diligence.
Joshua Duitz: But that happens in Closed End and Open End Funds. So I don’t think that makes a difference.
Gregg Abella: Correct. But it is something that can cause a discount to remain a discount for a very long period of time.
Sarah: Josh, let’s kind of focus in on what you brought to the table here. Why should a US investor be looking globally? I know you mentioned that before, but what is really the value in looking globally?
Joshua Duitz: You look back at the US economy, right, back in 1960 we made up 40% of the global GDP, now we’re about 24%, right. The world is a very big place and there’s opportunities outside of the US. So basically you’re opening it up, your viewpoint to looking at companies everywhere and there’s just more opportunities globally than there are if you just focus on the US. So I think that’s a very important part of looking globally. And for diversification purposes, when there are, you know, discounts in valuations outside of the US we should take advantage of them as investors.
Sarah: Is now a good time to be looking globally?
Joshua Duitz: You know, I do think so, going back to my previous comments, if you just look at the PE ratios and the price to book ratios, there are opportunities outside the US. And this is one of the largest discounts we’ve seen in valuations.
Sarah: Excellent. And why invest in stocks that pay dividends?
Joshua Duitz: If you look back historically the stocks that have paid dividends have outperformed, for hundreds of … I shouldn’t say hundreds, about a 100 years, stocks that have, have not paid dividends. So, one, you want to be in stocks that pay dividends, there’s good cash flows and they’re actually paying out those cash flows. And it’s interesting, when you look at the cash flows, I look at a company and if they know they have to pay a dividend every quarter or semi-annually, right, they don’t have as much cash to spend. So they’re going to be a little more disciplined in my opinion, on what they’re going to do with that cash. So I think that’s one of the reasons that dividend companies that pay dividends, outperform.
Sarah: Excellent. Ken, we’re going back to, I guess, improving the conversation, you have brought the point up of financial literacy. Talk about why that’s so important and maybe how that can really be pushed forward?
Ken Nuttall: Yeah. I mean that’s one of the things that we spend a lot of time at, at my firm is just informing people, educating people on why we are doing something and why we’re using a certain product, and what we’re trying to accomplish out of it. And a lot of, you know, you go on a website and sometimes you get some bad information out there and get everyone all excited about like the great growth stocks right now. And it’s like I should just be in Facebook and Apple, that’s all I should be purchasing. It’s like, no, you’ve got to have the diversification and be out there. So we spend a lot of time talking about why you’re doing this and why we have a certain investment in a certain thing. And one of the things is, people want to know what a mutual fund is, what a stock is, what a bond is or what a Closed End Fund is. And usually, you know, the Closed End Fund is the one where people are like, “I have never really heard of this before, what is this?” And so we have to spend a little bit more time, but.
Gregg Abella: I almost think they should change the name, it just implies, when my father and I talk about this, it implies like, keep out, right. And in other parts of the world they call them income trusts, which sounds a heck of a lot better in my opinion. But maybe the industry has to decide, does Closed End Fund really tell the story that we want to tell?
Sarah: So I know you guys have mentioned it a few times, discount, I feel like that would be a word that would sell it, no, what about like exploring discount with clients, with advisors, how does that help?
Ken Nuttall: Well, it’s one of the things we do explain on, you know, one of the benefits are pros and cons of the Closed End Funds is that they don’t necessarily have to trade at their net asset value. They can trade typically at the discount. But some of them do trade at premiums. I mean, there was some PIMCO funds a few years ago that were trading at multiples, like a 100, so it’s like kind of…
Greg Abella: Some of them still trade at premiums.
Ken Nuttall: ] It’s like why? But these discounts, why is it trading that way? And you’ve got people sit back and say, “Alright, if it’s trading at discounts does that mean the manager’s not working so well, because you can buy them for cheaper?” And I sit back and I’m just like, “Well, when you go to the supermarket or whatever, don’t you like buying things that are 10 or 20% off? Don’t you get more excited about that?” Here you’re getting $100 for 90 bucks, like why won’t you do that? All else being equal, obviously if the manager’s performing and everything, it’s fine. But if they’re not performing, but that, as we said earlier, that discount can get larger, there’s nothing that says it can only go down to 10% or whatever it is. And the managers have been trying to come up with ways of cutting those discounts.
Gregg Abella: Some of them do, some of them don’t. We always … well, not always, internally we discuss is the structure of the product in this day and age a fair one? Back in the day when there really were no other choices, the structure was the structure; you had to live with it. In this day and age because you have so many other options, is it fair in an environment where maybe yields blow out, that you might have to sell something where the underlying asset is trading 20% higher than the price that you’re selling it for? Are you unfairly disadvantaged? And is somebody unfairly enriched every time you sell something at a discount? Or is somebody similarly disadvantaged every time they buy something from you and it’s trading at a premium? So we wonder, is some day going to come when a smart regulator comes in and says, “We don’t like this anymore, we’re going to force you to cut these discounts down over time or turn your fund into an ETF.” I’m just, I’m throwing it out there as something that eventually somebody, it might occur to them that … I mean heck, when ETFs have traded at those kinds of discounts to NAV, I think in some cases those trades were busted. This is, it’s like the norm, right.
Sarah: Gregg, we were talking about some of the disadvantages of Closed End Funds.
Gregg Abella: I hate to concentrate just on the disadvantages because there are so many advantages. But there are disadvantages out there and I think if you start your due diligence process by working with managers who have aligned interests, some of the sponsors that have very good reputations, that have treated shareholders well, that manage their risk well within the portfolio, that your due diligence is partially done just by working with very responsible firms. We’d spoke a little bit about chasing yield or whether or not you’re chasing something down a hill, but if you’re chasing just a discount, that could be a reason for that, it could be by governance. So you don’t want to get into something and find out it was cheap for a reason. So I think governance is super important, is not the only due diligence piece you want to do, but it’s certainly a vital one. And then you start from there and then you look at the underlying holdings, do you like those? Are those ones you would buy if you were managing the fund? Is the leverage reasonable? Is the income being distributed actual income or is it return of capital? These are the sorts of things that as long as you’re doing that sort of diligence you should avoid a number of traps. It doesn’t mean you’re necessarily going to make money; an asset class is what it is. When a manager can’t necessarily do better, dramatically better in EM than the EM market is doing as an example, but if you take those steps at least you can avoid some pitfalls of the structure.
Sarah: Excellent. Josh, want to come back to you, why go global with dividend?
Joshua Duitz: So dividend stocks have outperformed over the past 100 years or so. And if you look at that also, we’ve looked at it just recently over the past 30 years, and stocks that pay higher dividends actually outperform stocks that pay lower dividends and stocks that don’t pay dividends. And if you look at the yield, I just looked at it recently, the yield on the S&P 500, it’s about 1.84. The yield on the Stocks 50, which is a basket of European stocks is twice that, it’s 2 x that. So companies outside of the US generally pay higher dividends. So we think those are good opportunities to invest and look at.
Gregg Abella: A number of … because we buy individual companies primarily in Europe that pay dividends. But sometimes those dividends are very sporadic, like they’ll pay once a year or at best, twice a year. So how do you manage your portfolio so that the distributions go out more frequently than the dividends that you’re paid?
Joshua Duitz: So in Europe they actually generally pay once a year, in the UK it’s generally twice a year, so, and that’s due in March, April, May. And on the Closed End Funds as I mentioned, that it’s nice to get the active piece, so we actually have a steady dividend that we pay monthly. And so we’ll earn actually more dividends early in the year and then distribute it throughout the year.
Sarah: Very interesting. Josh, you were nice enough to contribute a chart to our conversation today, give us a sense of what this is representing here.
Joshua Duitz: Really it just shows stocks that have paid dividends versus stocks that have not paid dividends, the returns over the past 90 years or so. And you could see that stocks that have paid dividends historically and continue to outperform stocks that don’t pay dividends. So that’s something that, you know, we’ve seen historically, we think will continue and we like companies that pay dividends.
Sarah: That’s a great looking chart, yeah, go ahead, Gregg.
Gregg Abella: If you compress this to more recent history where growth has so far outperformed value, would it show a different story, or is it over a very long period?
Joshua Duitz: So just literally within the past few days I was asking the same question. And we actually took the data of the MSCI All Country World Index and we broke it up between stocks that have paid dividends and that stocks that had not paid dividends over the past 30 years, so since 1987 or so, 1988, I believe, so the past 30 years we’ve looked at that. And stocks that had paid dividends have still outperformed stocks that have not paid dividends over the past 30 years. And then again that’s an MSCI All Country World Index that we looked at, so. And there are differences over the past 30 years actually, the highest dividend paying names have outperformed. If you look at it since the financial crisis, the stocks that have paid dividends and the range I believe, roughly 3% have outperformed. So that’s probably in the 4th or 5th decile of the stocks that actually paid dividends. But again, all those stocks have still outperformed stocks that don’t pay dividends, and stocks that pay higher dividends generally outperform stocks that pay lower dividends.
Gregg Abella: In the US some of the companies that have been high dividend payers are actually paying more than their free cash flow permits, and they’re borrowing money to do it. Is that the case in Europe too or no?
Joshua Duitz: You do see that and certainly that is a huge red flag when you see that. So one of the things that we do look at for dividends are companies in the payout ratios, and also their cash flow where it’s going to be, so once in a while you will see a company that pays out more than they should. But you understand that their cash flows are going to grow into that. And the cash flows over the next few years are going to be much higher. So they could afford to do that for a year or two. But certainly that’s a huge red flag when we see that they’re paying out more and they’re borrowing to pay out.
Sarah: Ken, we’re going to come back to you, talking about seasonality, how do I pose that to you? I’m not even going to try, yeah.
Ken Nuttall: I’m not even sure that’s the completely right term, it’s more what happens in the Closed End Fund market, it’s a very retail heavy investor base. So you don’t have like the professionals out there as much, it’s more mom and pop who are buying this. And what you kind of see at the end of the year, November/December timeframe is some selling for it. And it’s more of a tax selling. So I have a loss here, I have a gain over here, when we offset, this type of thing. And kind of what you see, you know, general is that the discounts on these Closed End Funds happen, get bigger come November and December. And then kind of go back, all else being equal, in January, back to their normal thing. So I call that seasonality, I’m not sure if there’s another proper term for it, but.
Sarah: I like that, I like seasonality, yeah.
Joshua Duitz: and again there’s an opportunity when you do see that, it happens regularly.
Sarah: That’s great. What about the use of permanent capital?
Ken Nuttall: So this is one of the great things I like about the Closed End Funds is that they’re not getting redeemed on, and they can go out and buy the more esoteric or illiquid assets. So like there’s a lot of business [inaudible] companies who are lending out to small and mid cap companies and they couldn’t do that in a mutual fund wrapper or an ETF wrapper because they could get called. We’ve seen a mutual fund that blew up last year or two years ago, who were kind of doing something similar. So it’s a great place to kind of have the permanent capital and have the ability to invest in the more esoteric or illiquid asset that, you know, a normal mom and pop might not have the ability to invest in.
Sarah: Josh, do you want anything about permanent capital?
Joshua Duitz: I think it’s important, as I mentioned earlier, just the fact that you’re not forced to sell in the market, when we see EM getting hit per se or the markets going down you’re not forced to sell and you’re not forced to buy. And you could actually plan for your dividends to your last question, so that to me is what is nice about permanent capital.
Gregg Abella: And you can make decisions for the long term, you’re really not trying to make the decision just what’s a quick easy trade possibly. You could actually have a long term view on markets and companies, and which is important because the fundamentals really play out over time.
Sarah: Excellent. Ken, let’s talk about the cost of a Closed End Fund and pulling away the leverage costs.
Ken Nuttall: So a lot of times it’s just that sometimes people get tricked up on this, because, again with the ETFs an all, a lot that play there is that it’s low cost, very cheap type thing. When you can buy the SPY for 6 or 7 basis points, when you can pay on some of these Closed End Funds that are charging much more, it can get a long conversation. And the other thing that Closed End Funds have is what they’re leveraged at, leverage costs gets embedded into their cost. So you have the manager’s cost, of say 1%, an example, but if they’re using leverage and using professional leverage, there’s an additional cost of 2%, making up a number here. You go and have a look and like, why is this thing costing 3%? And people have a hard time comparing that to an ETF because they’re trying to do apples to apples when it’s really apples to bananas, they’re completely different. And people just need to understand that you’re paying out for something at leverage to get more of the yield or whatever it is here. And it’s just another thing of, you know, being able to educate people on what they’re buying.
Gregg Abella: Business development companies are even harder to explain, purely by cost because they charge 2 and 20, so right off the bat the expense ratio in a great year could be double digit.
Sarah: Let’s talk about benchmarking success, Gregg, you had a good question for Joshua.
Gregg Abella: Josh, within your own funds that Aberdeen manages, how do you benchmark them, particularly global funds where you’re investing domestically and internationally? How do you benchmark whether or not the fund is achieving its goals, it’s succeeding the benchmark, doing better or worse and what, I suppose what steps do you take to make sure that it’s within the right bounds?
Joshua Duitz: [0:37:53] So that’s a great question. So our benchmark for the two that I manage, AOD and AGD, is the MSCI All Country World Index, right. So we look at that index and that’s a first step in benchmarking. And then we also look at our global peer group, a peer group that was chosen for us by an independent body. So this way we could also see how we’re doing versus our peer group, right. Because the MSCI All Country World Index has stocks that pay dividends and don’t pay dividends, so our goal is if we can match or beat that benchmark, and we pay a much higher yield, the yield off the market price is roughly 8% now, versus a much lower yield on the MSCI All Country World Index, we’re actually achieving our goals and certainly if we beat our competition that’s even better. So that’s really how we try to benchmark ourselves. And with that I look at that and we’re not benchmark huggers, there’s over 2,000 names in the MSCI All Country World Index but I am trying to look at it by region and by sector. Because I don’t want to make major bets on a region or a sector, I will make some bets, but smaller bets because really as a fund manager my advantage I believe, or our advantage as a global equity team, we have analysts globally which is great. But also is the fact that we’re fundamental stock pickers. If we could beat each and every sector then we’re going to outperform the benchmark and outperform our peers. And that’s what we’re really trying to do, we’re trying to understand the company, understand the cash flows, understand the moats around the business and that’s how we choose the companies that we decide to buy in.
Gregg Abella: Do you have a bias towards growth versus value, dividend versus no dividends?
Joshua Duitz: Well, clearly these are dividend funds and we believe that dividends outperform, so over 95% of the stocks, probably closer to 98% have a dividend in our fund. And growth versus value, I would say, we look at growth companies that add value to them. We’re not momentum chasers and if I see PE ratios at 40/50 times I get scared. So I would say definitely more on the value side or I like to say growth with value, so I would say much more value oriented, which has been somewhat difficult over the past couple of years. So that’s why we’ve been fairly happy in this environment that we’ve been able to basically over the past 5½ years, since we’ve been managing the fund, be basically in line with the benchmark.
Gregg Abella: And skewed more towards large cap than small and mid?
Joshua Duitz: I would say in AOD which is the largest fund, definitely skewed mid/large cap. But we will look all across. But liquidity is important to us, so.
Sarah: Excellent. Excellent, thank you very much. Ken, coming to you, benchmark fund manager performance?
Ken Nuttall: Yeah. So we kind of look at it for all the products, so Closed End Funds to ETFs and mutual funds, we kind of like, we look at what their indexes are, that are doing it. And we care what their processes are, especially for non-indexes like, how’s this guy done in the last 5, 10, 15 years? Because like the last 10 years has kind of skewed everything, that everyone looks great in the last 10 years. But you want to kind of look longer, probably how there’s not all managers have been around that long or fund managers, and that gets a little tough. But I am kind, I believe you’ve got to understand who you’re putting your money with, and if they’ve had success in the past, most likely to have success in the future. Obviously it’s not always guaranteed or anything like that, but we, you know, look at it both on a quantitative and qualitative and I don’t think there’s really a big difference between looking at a Closed End Fund versus a mutual fund versus an ETF in that kind of circumstances.
Sarah: Fantastic. This has been an incredible conversation, much more intriguing than I thought it was going to be before we started, I’ll be honest, Closed End Funds, there’s a lot to them, I’m very surprised. Let’s leave our audience with some key takeaways from this and give your closing remarks for this conversation, Gregg, we’ll start with you.
Gregg Abella: Well, I’d like first to thank you for having me attend and participate, and it’s always fun to talk about Closed End Funds when it’s 100 degrees outside, so thank you.
Sarah: It’s a hot topic.
Gregg Abella: ] It’s a hot topic. These were just my opinions here today, my firm and I … I don’t know if I speak on your all behalves as well, but for compliance reasons, this is how I personally feel about Closed Ends. But it is an interesting asset class, if done right and you work with responsible sponsors, it can be very rewarding for your clients, income which is so vital for so many investors, can be achieved through the structure. And as long as you’re picking good managers and you’re aware of the risks within the asset class itself, I think it can be a great component to a very well diversified portfolio.
Joshua Duitz: Great, thank you, thank you for having me and thank you both, and thanks for the kind words about Aberdeen, those were very nice. So I will say a couple of things, one, we do think there are advantages of Closed End Funds and certainly trying to take advantage of discounts. We’re looking at managers who have outperformed their benchmark and their peer group and actually like you said, objectives of each and every fund. And we truly believe that investors should be looking globally, it’s a large world out there, there’s many opportunities. And stocks to invest in that pay dividends have historically outperformed and we believe they will continue to outperform, you know, given the cash from a company, it’s tangible, right. They can’t fudge the numbers on the cash they’re paying out each and every quarter or annually or semi-annually. And it’s there for us to receive and then reinvest in or pay them out to our shareholders.
Tim Nuttall: Well, thank you for having me here today. It’s always interesting to be able to talk about Closed End Funds because it’s a little part of the investment universe that not many people know about. Closed End Funds can be very useful to investors if used correctly, you know, the advantages of having the discounts and the leverage and the ability to use permanent capital on them is something that investors should definitely have for themselves.
Sarah: Excellent. Well, gentlemen, thank you so much for being here today. And thank you for tuning in, I’m Sarah Makuta and this was the Closed End Fund Masterclass.