With all the panic over the headlines these days, it’s a good time for us contrarians to step back and take stock—because there are high-yield bargains out there that can help us navigate this mess.
(Hint: the best hunting ground for us contrarians today is in a group of roughly 500 funds called closed-end funds, or CEFs, many of which pay 8%+ yields and trade at ridiculous discounts. More on them, and a 9.9%-paying fund that might be a good fit for you if you’re investing for the long term, in a moment.)
First, if you’re feeling nervous about your portfolio, let’s step back a bit. Because there are reasons for optimism. For one, consider that the stock-market rebound coming out of the COVID-19 crash remains robust, despite the mess 2022 has been. Investors who just bought an S&P 500 index fund back then are still sitting on 84% gains in just over two years!
What’s more, we had a lot more reason to think the world was ending back then than we do now. While the war in Ukraine remains a humanitarian disaster, most of the rest of the world’s population is out of their homes and going about their lives. That’s not something you could say about March 2020.
The takeaway is that selloffs have always been—and remain—opportunities for long-term investors. But getting into stocks is just the first step. You can compound your profits by purchasing your stocks (and bonds, and REITs, and preferred shares …) through CEFs.
CEFs have a similar structure as ETFs, with one key difference: while ETFs trade pretty much at the market value of their portfolios (their net asset value, or NAV), CEFs trade at a price higher or lower than their NAV—and most trade at discounts. Contrarians who buy when these discounts are unusually large have a chance to augment their profits while hedging their risk.
The CEF Discount in Action
To show you how this works, consider the Highland Global Allocation Fund (HGLB), a diversified CEF that splits its assets across different geographies and assets, with a mix of stocks, real estate, loans and bonds issued to US companies (which all together make up three-quarters of the fund) and foreign firms (which make up the rest). HGLB yields 9.9% now and trades at a 22% discount, making it one of the cheapest CEFs on the market today.
This isn’t its biggest discount, however. When markets hit bottom in 2020, HGLB was really oversold, with a 45% discount to NAV that was almost inconceivable before the pandemic hit. Investors who saw opportunity in others’ fear were amply rewarded.
With a market-doubling return from the lows of the COVID-19 pandemic, HGLB brought considerable profits to investors who saw past the fear in the market and bought the fund’s irrational markdown. And HGLD continues to perform well, even as the S&P 500 falls.
HGLB is a good example of how buying a CEF trading at a big discount can help hedge your portfolio in a downturn while enhancing your gains in a rising market. While its discount may go down further in the short term, a long-term play here could see significant capital gains as the market goes from fearful to greedy—as it always does.
The Cheapest CEFs Now
This is a particularly interesting time for CEFs, because the selloff has resulted in a lot of funds that are oversold. Just consider these facts:
- The average CEF now yields 8% at a time while US Treasuries yield 3% and stocks yield 1.3%.
- The average CEF trades at a 5.3% discount to NAV, versus a 1.3% discount to NAV just a year ago.
- A total of 89 CEFs trade at a discount of 10% or higher, the most in the last five years (excluding the first half of 2020).
- Of those 89 CEFs, every single one that has been around for a decade or longer has had a positive return in that time, with several funds earning annualized returns over 10%.
The bottom line is that we have an opportunity to use the selloff to secure an 8%+ income stream from oversold CEFs. That would give you a healthy cash stream at a time when folks who mainly stick to the pathetic yielders of the S&P 500 must sell stocks at today’s low prices to ensure they have enough money coming in.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 8.4% Dividends.”