Positive returns across asset classes in 2019 may limit tax loss selling in closed-end funds, but we see potential long term value in select sectors where investors can still buy assets at a discount.
2019 has been a strong year for closed-end funds (“CEFs”), with double-digit net asset value (“NAV”) returns in many sectors (Exhibit 1). Additionally, discounts have narrowed over the course of the year, driving market price outperformance versus NAVs. Positive market price returns may lead to fewer opportunities for investors to employ tax loss selling strategies in 2019. However, given the income focus of many CEFs, and the large distributions they pay out, the current market value may be lower than an investor’s cost basis, resulting in a capital loss. Moreover, CEFs held for more than one year may be in a capital loss position. Although tax loss selling may be limited compared to 2018, the fourth quarter has historically exhibited discount widening prior to year-end as investors seek to harvest capital losses to help reduce current year tax liabilities. That being said, BlackRock believes the dearth of yield opportunities across the globe will keep demand for CEFs high and could lead to tighter discounts in the near future.
The January effect
Based on historical trends, investors that have purchased CEFs in the latter part of the fourth quarter have generally realized the benefits of tax loss selling through the short-term effect of discount narrowing (market price outperforms NAV) most prevalent in the month of January. Notably, CEF discounts have narrowed in January in 16 out of the last 20 years. This consistency may be attributed to the ‘January Effect’. According to this theory, pent up demand following tax loss selling may be the factor driving the outperformance as investors re-enter the market after selling positions in prior months to harvest taxes and rebalance their portfolios. Based on historical trends, BlackRock believes that tax loss selling may present an opportunity to reap the rewards of a temporary mispricing in the CEF market.