Competing fund-of-funds ETFs signal CEFs may be heating up.
In an era where investors are looking for alternative sources of income that go beyond a traditional allocation to bonds, ETFs that invest in closed-end funds (CEFs) have found a growing following. Their appeal essentially centers on the relatively high income they are known to deliver.
In this small corner of the ETF market, there are two major funds competing for investor dollars. The PowerShares CEF Income Composite Portfolio (PCEF) is the older of the two, having been around now for four years, and boasting nearly $505 million in assets. In the past year, investors have poured a net of about $125 million into the fund as it rallied.
Competing against PCEF is the seven-month-old YieldShares High Income ETF (YYY), which came to market as the result of a soft closure of an oil sands ETF that went by the ticker “SNDS.” YYY has gathered just under $24 million in total assets.
The two funds set out to capture the income potential of the closed-end fund space, but they go about it differently, even if their performance over the past six months has been very similar. PCEF saw total returns of 8.2 percent, while YYY returned 8.4 percent in the period.
Chart courtesy of StockCharts.com
CEFs are funds that are closed for new investment and share creation, unlike ETFs, which have an open creation/redemption feature.
That trait means CEFs often trade at premiums or discounts to net asset value because arbitragers in the market can’t turn to the creation/redemption system to keep the market price linked to fair value, according to ETF.com Analytics.
It is in those premiums and discounts that a lot of the income opportunity lies. In theory, CEFs that trade at a discount to NAV could deliver a chance at price appreciation. It’s also the case that an “undervalued” CEF would enhance the overall yield of a fund relative to the price paid for that position. That’s why these ETFs tend to focus on the CEFs that show the greatest discounts.