On this episode of “What Makes That Ticker Tick,” VettaFi CMO Jon Fee brought on Roxanna Islam, associate director of research at VettaFi, to discuss the CEFX.
The CEFX Index
Jon Fee: Welcome back to What Makes That Ticker Tick. This is a show where we tackle about 10 key questions around a specific ticker in 10 minutes or less. The ticker today is CEFX. It is the SNET Composite Closed-End Fund Index. It’s a mutual fund index. It’s a little bit different than what we’ve talked about on the show in the past.
My guest today is none other than the associate director of research at VettaFi. Roxanna Islam is joining us live from Dallas. How are you doing today, Roxanna?
Roxanna Islam: I’m good, John.
The Investment Case
Jon Fee: Thank you for joining us. I’m excited to discuss CEFX today with you on What Makes That Ticker Tick. We’re going to talk about index use cases. We’re going to cover index construction, we’re going to dive into performance. And then last but not least, we’re going to go into my favorite part of this show: What’s inside?
What are some of the constituencies and some of the names inside this particular index? Roxanna, let’s start with what is the objective or the investment case behind the index of CEFX.
Roxanna Islam: CEFX serves as a benchmark for the taxable close-end fund universe, which is basically everything except the tax-exempt portion of the market. And those are the municipal bond closed-end funds. If you don’t know a lot about closed-end funds, these typically have a primary objective of generating income. These tend to have distribution rates in the high-single-digit to low-double-digit range.
Pretty significant distributions there. So an ETF that tracks an index like CSX would be good for an investor who maybe wants that stable income stream, but maybe isn’t too familiar with closed-end funds and isn’t comfortable picking individual funds or maybe even for an experienced close-end fund investor who wants to use this as sort of a core closed fund holding in their portfolio.
What Separates the Index From Other Products?
Jon Fee: Sounds like it could be an incredibly convenient holding if you don’t want to do all the other work, but just want that exposure. Staying on index use cases, Roxanna, at a high level, what makes the the CEFX index different than other similar products in the marketplace?
Roxanna Islam: So it’s a really small peer group. There are actually only a few other pure closed-end fund indexes that support ETFs. The first is the S-Network Municipal Bond Closed-End Fund Index. This is very similar to CEFX, a very similar methodology, except it benchmarks the missing portion of that market, which is the tax-exempt or municipal bond portion. Maybe a little bit of a closer peer is the ISE High Income Index, which is the ticker YLDA.
That is similar yet different because it focuses more on selecting closed-end funds with high distribution rates and appreciation potential rather than trying to benchmark the entire universe. So this one, for instance, has a max of 45 constituents versus the 110 that are currently in CEFX.
CEFX Index's Starting Universe
Jon Fee: Such a great segue because I want to talk about index construction next. What is the starting universe of the index? And you just mentioned that it gets down to 110 constituents, but what’s the starting universe?
Roxanna Islam: So there are actually only 450 closed-end funds in the U.S. Over 100 of those are in municipal bond closed-end funds. And then here we’re looking at a couple of main areas. Those are taxable fixed income, which includes both high yield and investment grade, and also equity option income. After you take all those out, that’s about a couple hundred closed-end funds to choose from — still a pretty sizable universe.
Factors Used to Select Companies for CEFX Index
Jon Fee: Moving through index construction, what are some of the factors used to select companies for inclusion in this particular benchmark?
Roxanna Islam: This is where I think it gets a little bit interesting. Because the index screens for things like minimum market cap and minimum trading value; things you’d expect. But there are some really interesting industry-specific factors as well. Funds are limited to a max of a 1.25 to 1.5% management fee. And that sort of depends on whether they’re a current constituent or a new constituent.
This is because when this index is translated into an ETF, it uses a fund-to-fund structure. So you have that additional management fee for the ETF on top of those fund expenses. So what this rule does is really tries to minimize those acquired fund expenses so that the investor isn’t paying, crazy amounts of expense for this particular product.
Another cool thing that it does is it excludes any closed-end fund that’s trading at a significant premium. It also gives a higher weight to closed-end funds that trade at a wider discount. This is really cool because it actually replicates a popular trading strategy that managers have where they buy at low discounts and sell at high premiums.
How Often It Is Rebalanced or Reconstituted
Jon Fee: Interesting. It holds investment-grade fixed income and closed-end funds. It holds high yield fixed income closed-end funds, and then also option income closed-end funds. How often is it rebalanced or reconstituted?
Roxanna Islam: It’s rebalanced and reconstituted quarterly. I think that sort of gives it more of an active feel compared to its competitors. So I mentioned YLDA earlier, so that one’s only rebalanced and reconstituted semiannually. I like that quarterly schedule better for this particular index. That’s because that premium discount mechanism that closed-end funds have can be volatile. So it’s nice to be a little bit more hands-on with that.
CEFX Index Performance
Jon Fee: I want to pivot to performance measurement, given the three main sectors that underpin this index-challenged environment. Roxanna, how has performance been a year to date? And then talk me through some of the environments where this index would perform very well versus the challenged one we’re in right now.
Roxanna Islam: Unfortunately, a high rising-rate interest rate environment is the most difficult for closed-end funds. Right now, total return has been about flat year to date. That’s that’s pretty standard across the whole industry, not just for this index that we’ve seen that performance suffer. About two-thirds of closed-end funds within the closed-end fund universe use leverage that’s typically in the form of preferred shares.
So if you think about it, when you see rates start rising, the cost of borrowing is also higher. That then sort of eats into those closed-end fund profits and could potentially lead to distribution cuts. But from an index perspective, I think that’s a little bit less likely to be significant. That’s because you’re diversifying across strategies, across managers, and across individual funds.
Also, if you consider the actual distribution rate — which is pretty important for closed-end funds because they pay out their gains as income — it’s still been close to 11% in the past 12 months. So in a way, distributions are pretty important for closed-end funds relative to total return. That’s because a well-managed closed-end fund may be able to weather some of that total return deterioration and maintain that stable income stream in the short term.
The Companies Found in the Index
Jon Fee: I like it. Roxana, we’re going to move on to my favorite section of What Makes That Ticker Tick: What’s inside? Would you talk about some of the constituents of the index, CEFX? What are some of the constituents inside this particular benchmark?
Roxanna Islam: It’s pretty diversified. And that’s, as I said, in terms of sector, in terms of manager, in terms of individual funds. So it’s about 50% option income, 30% high yield, and 20% investment grade. And then it’s even further diversified among managers. Some of the big managers found in this index include BlackRock, Eaton, Vance, and Nuveen. When you look at the top holdings, you see these top managers reflected.
Jon Fee: What about some of the lesser-known constituents? Everybody knows BlackRock is the world’s largest asset manager. But what are some of the lesser-known constituents in this index?
Roxanna Islam: I like some of the floating rate funds in this index. Because I think these are pretty appealing in this sort of environment we’re in with the rising rates and all the big names you and I mentioned, like BlackRock, Eaton, Vance, Nuveen. They all have floating rate products in this index. But there are also some smaller ones in there, like the Pioneer Floating Rate Fund, and the First Trust Senior Floating Rate Income Fund.
These are smaller funds that have distribution rates in the low double-digit range. I think these are closed-end funds that invest or that are maybe doing their own research might miss in favor of some of these larger names that we mentioned.
Jon Fee: Gotcha. All right, Roxanna, that’s the end of What Makes That Ticker Tick, specifically for the ticker CEFX. The S-Network Municial Bond Closed-End Fund Index. I want to have you back on the show. I think you did a phenomenal job today. You pick the ticker. I’ll pick the questions. I’ll see you next time. Thank you, Roxanna.
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