By Michael Foster
Every so often, a CEF Insider subscriber asks if I see oil-related closed-end funds (CEFs) as solid income plays. You might be wondering the same, given the surge in oil prices aEUR"and oil stocksaEUR"since the start of 2019.
Today weaEURtmre going to answer that question. Along the way, weaEURtmll uncover an energy CEF you need to steer clear of, no matter how you feel about oil.
LetaEURtms start by making a quick run through history: what would have happened if you invested in energy CEFs over the last few years?
Source: CEF Insider
While the last three years have seen a decent average annualized return, and a negative return if you got in five years ago. Even that 7% average annualized return over 10 years isnaEURtmt great: the average US equity CEF returned 10.5% with a lot less volatility.
Still, a 22% jump in oil prices this year has plenty of folks either forgetting this history or turning a blind eye. ThataEURtms translated into some crazy market-price trends for energy CEFs. For instance, look at Tortoise Energy Independence ( NDP ): the discount to NAV it held in 2018 shot to an absurd premium in February, although itaEURtms cooled a bit recently:
An Overbought Energy CEF
Does NDP deserve a 7.6% premium? No way: its NAV has collapsed 35% since its 2012 inception, even if you include dividends:
A Portfolio in Free-Fall
Speaking o f dividends , this fund yields an absurd 21% today. But this is a warning sign because itaEURtms backed by the collapsing NAV we see above, which puts this dividend in serious danger of being cut.
But if NDP is a bust, does that mean we need to avoid all energy CEFs now? LetaEURtms answer that.
At first glance, the answer would seem to be no. After all, the average discount to NAV for all energy CEFs is 8.8%aEUR"pretty attractive compared to the historical average:
Discount Looks GoodaEUR"at First
Source: CEF Insider
But go a bit deeper and things donaEURtmt look so rosy.
LetaEURtms start with OPEC, which recently announced that it would need to continue its output cut till the end of the year. While that sounds bullish for oil prices, it actually isnaEURtmt, because American production has kept growing as a result of WTI oil futures being above $40 per barrel, the typical breakeven point for most US producers. This ongoing shift of oil production from the Middle East to North America will continue to limit OPECaEURtms ability to boost prices.
So if the macro story isnaEURtmt looking great for oil, what about technicals? LetaEURtms look at those now:
Oil Locked in a Vise
There are clear resistance points between around $40.50 and $61.50, and, at $57, oil is now at the high end of that range.
This tells us is that oil is high but not obscenely high, and the chances of it going down are greater than the odds of it going up. A simpler way to put it: oil funds should be pricing in the probability of a drop in oil, not a rise.
If your fund is not pricing in a drop, and irrational exuberance has driven its market price far above its NAV, itaEURtms time to sell.
Right now, 53% of energy CEFs have year-to-date price gains above their NAV gains, and 30% have price gains just 3% below their NAV gains. Only two funds havenaEURtmt seen this kind of overdone price rise: the Kayne Anderson MLP/Midstream Investment Company ( KYN ) and the Kayne Anderson Midstream Energy Fund ( KMF ) , which have posted price gains 5% below their NAV gains.
This isnaEURtmt surprising, as Kayne Anderson tends to attract savvy investorsaEUR"but these funds have had some awful downturns when oil falls, so buying them now could expose you to those risks for as long as WTI sticks above $50.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.