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Bob’s Journal for 4/11/19

Last update on: Nov 22 2019

Closed-end mutual funds can increase your portfolio returns, but investing in them has an extra layer of risk.

There’s a key distinction between closed-end mutual funds and the better-known open-end mutual funds.

An open-end fund doesn’t have a fixed number of shares issued. Instead, at the end of each day, the fund company tallies the total value of the fund’s portfolio, as well as the new investments and redemptions for the day.

Based on the value of the portfolio, it issues new shares for the new investments. Each share has the same net asset value and can be redeemed for the net asset value.

A closed-end fund (CEF) has a fixed number of shares. The CEF goes public much like a company does, and its shares trade on a stock exchange. The net asset value of the fund changes as the investments in the portfolio change. But the CEF’s share price changes with the demand and supply for them.

A consequence is that shares of a CEF rarely trade at the net asset value. Instead, the shares trade at more than the net asset value (a premium) or less than the net asset value (a discount).

I periodically recommend CEFs in our Retirement Watch portfolios, especially the Retirement Paycheck portfolio.

As a general rule, you don’t want to buy a CEF unless its shares are trading at a discount to its net asset value. You’re buying a share of the portfolio for less than it’s worth. It is even better to buy a CEF when the shares are trading at a discount that exceeds its average discount for the last year or so.

I don’t want to buy a CEF that’s trading at a premium. At some point, it’s likely that the shares will decline in value until they trade at net asset value or worse.

A case in point is the recent behavior of some PIMCO closed-end funds. Examples are below.

PIMCO Global StocksPLUS Income (PGP) sold at enormous premiums. In 2016, the premium peaked at 105.23% of net asset value. Its average premium over the last 10 years is just below 60%. In 2018, it had an average premium of 31.16%, and in 2018 its average premium topped 51%.

PGP invests a portion of its cash in stock index futures and the rest in bonds. It also uses leverage. The result was it delivered stock-like returns, plus a yield that averaged almost 10% the last few years.

That was a deal that was hard to turn down for many investors. But it also wasn’t sustainable.

PIMCO recently reduced the fund’s distribution by 23%. PGP quickly declined more than 11%, wiping out more than a year’s worth of yield in one day. The fund is down more than 13% over the last month.

Other PIMCO CEFs had a similar experience.

PIMCO High Income (PHK) had its distribution reduced 24%, and it declined 11% in one day. Its premium was over 47%.

The distribution of PIMCO Strategic Income (RCS) was cut 15%, and the fund declined almost 7% in one day.

Some other PIMCO CEFs, including tax-exempt bond funds, suffered distribution cuts and sharp price declines.

This experience is one reason why I insist on a margin of safety in the investments I recommend. These CEFs have had high premiums for years that made many investors believe the premiums were sustainable. But they weren’t. More importantly, it makes them vulnerable to any bad news that comes along. There’s no way to know when an event will come along that will cause their stock prices to take a hit.

The Data

Inflation increased a bit in March, but that was mostly due to higher energy prices. The Consumer Price Index (CPI) increased 0.4% for the month and 1.9% over 12 months. But after subtracting food and energy, the CPI increased 0.1% for the month and 2.0% over 12 months. Energy increased 3.5% for the month but still is down 0.4% over 12 months.

The Producer Price Index rose 0.6% for the month and 2.2% over 12 months. Excluding food and energy, the PPI increased 0.3% for the month and 2.4% for 12 months. Energy prices rose 5.4% in March in this index.

Small business optimism is largely unchanged, according to the NFIB Small Business Optimism Index. The index rose to 101.8 from 101.7. While the index is at a good level compared to its history, it is below the range of 105 to 110 that prevailed through much of 2018. The index tumbled to around 100 early in 2019, largely because of the government shutdown and hasn’t recovered much.

Factory Orders were poor in February. New orders declined 0.5% and January’s report was revised lower to no change from a 0.1% increase in orders originally reported. Core capital goods, an important measure of business investment, declined 0.1% in February. This is a big disappointment after the 0.9% increase in January.

The growth of Consumer Credit was about the same in February as in January. Revolving credit, which is mostly credit cards, increased more than the low levels of the previous two months. But most credit still consists of student loans and vehicle loans. Consumers are cautious about borrowing to spend on other items.

New unemployment claims declined another 8,000 to bring the total to 196,000. That’s the lowest number of weekly new claims since late 1969. The labor force was about half of its current size back then.

Last week’s Employment Situation reports were better than expected. The number of new jobs increased by 196,000. The previous month’s jobs were revised higher to 33,000 from 20,000. But average hourly earnings increased only 0.1% for the month. Average hourly earnings jumped 3.2% for the past 12 months.

The JOLTS (Job Openings and Labor Turnover Survey) report confirms that the job market slowed in January. This report is more detailed than the monthly Employment Situation reports but lags those reports by a month. The JOLTS report found that job openings declined in February and were below expectations. Hires also declined 2.3%. The number of job openings and hires were the lowest since spring of 2018.

The bottom line is the labor market still is strong, but there are signs that it isn’t as robust as in 2018.

The Markets

The S&P 500 rose 0.65% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 0.15%. The Russell 2000 increased 1.39%. The All-Country World Index (excluding U.S. stocks) gained 0.34%. Emerging market equities rose 1.67%.

Long-term treasuries gained 0.62% for the week. Investment-grade bonds rose 0.88%. Treasury Inflation-Protected Securities (TIPS) added 0.55%. High-yield bonds increased 0.65%.

On the currency front, the dollar declined 0.23%.

Energy-based commodities rose 1.90%. Plus, they’ve now increased 18.69% in 2019. Broader-based commodities rose 1.17%, while gold gained 1.38%.

Bob’s News & Updates

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Seriesclick here.

A recent five-star review of my book on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

I’m a regular contributor to the Forbes.com blog. You can view my contributor page here.

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.

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