It is important to note that as the fourth quarter gets underway there is the potential for tax-loss selling in parts of the markets like International and Small Cap and Closed end funds later in November and December. Tax-loss selling is when investors sell securities to realize losses for tax purposes in order to offset gains within their portfolios. Some parts of the market are lower by 9.00% YTD, so we could see some tax-loss selling this quarter. Should we see this volatility and discounts to historic return expectations widening as a result of tax-related selling, I would view it as a buying opportunity since I expect selling to be short lived (as historically in January and February of the following year investors take advantage of the prior quarter’s weakness and scoop up the value that was created as a result of the seasonal tax-related weakness). I continue to firmly believe the best approach for most investors is to dollar-cost average across many different categories of the investment marketplace.
From my standpoint, attractive opportunities are currently present in many categories including the usually under examined market of Closed End Funds (CEF). In this market equity CEFs, credit-sensitive taxable fixed-income (including senior loan, high-yield, limited duration and multi-sector) and investment-grade municipals all are underwater YTD. The Federal Reserve (the Fed) is very accommodative and the global economy is beginning to open up again after it was shut down as a result of the Coronavirus so there are many reasons to expect recovery and an upside experience from many parts of the world markets. CEFs offer a really interesting opportunity right now for a significant reason when you think about lifetime income – the average CEF has a distribution yield of 7.62% (Morningstar, as of 9/30/20). With the Fed keeping short-term rates near 0% for at least the next couple of years, yields on many traditional fixed-income asset classes (including certificates of deposit and U.S. Treasuries) will also likely remain very low. Therefore, the high distribution yields CEFs provide will likely become all that much more attractive on an absolute and relative basis as investors look to increase yield in their portfolios. I believe in an era of very low global interest rates, demand for the CEF structure will increase and discounts to NAV will narrow as more investors are willing to invest in CEFs as they look for the potential to generate cash flow from their portfolios.
If you would like to talk about tax loss selling and how to increase portfolio yield, I am standing by.