Has The CEFL Rebalancing Train Left The Station?
Summary A previous article attempted to predict CEFL/YYY’s new composition for 2016. Three groups of CEFs are analyzed for their recent price, premium/discount and volume behavior. Frontrunning in the underlying CEFs may have already begun. Introduction In last week’s article ” Are You Ready For CEFL’s Year-End Rebalancing ?”, I discussed the fact that not only was the annual rebalancing of the ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ) nearly upon us, but that the index provider has modified its methodology this year so that changes to the index are no longer made public five days before the actual rebalancing event. Ostensibly, this change was enacted to prevent “front-running” of the index (for more information, refer to ” Frontrunning Yield Shares High Income ETF YYY And ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN CEFL: Could You Have Profited ?”), which last year caused heavy losses to CEFL holders as well as those of the YieldShares High Income ETF (NYSEARCA: YYY ), an unleveraged version of CEFL. Both CEFL and YYY track the ISE High Income Index [symbol YLDA], an index consisting exclusively of close-ended funds [CEFs], and both pay high, monthly distributions. However, although the index changes are not announced publicly beforehand this year, the index methodology is published and available to all. Therefore, I was quite certain that professional investors would be able to apply the index methodology to accurately determine which CEFs were to be added or removed from the index. Therefore, two days ago I attempted to replicate the index methodology in order to level the playing field for Seeking Alpha readers. As described in ” CEFL: A Year In Review, And A Prediction Of What’s Ahead “, my crude attempt to reproduce the rebalancing algorithm resulted in the identification of the 16 CEFs that could be added to the index, and the 16 CEFs that could be removed. 14 CEFs are predicted to remain in the index. I stressed that my predictions were only an estimate given that I used only an approximate volume ranking and also because I did not know the exact date from which the index provider would harvest the CEF data. However, I did receive some confirmation on my predictions from reader waldschm85 : Thanks for the article SC! I recalculated this morning and 27/30 of our holdings match. I did go ahead and use the volume as a filter so that is likely the difference. There are a few like NHF and TDF that I’m worried won’t meet the threshold based on the 90-day average volume from Yahoo Finance. That being said, I’m feeling good that some of your top holdings with solid volume like KYN, NFJ, BCX, RVT, etc. will be in the index. Another astute reader, Jhinkle, noted : 11 out of 15 to be sold had abnormally high volume on the last trading day. As well most were flat to slightly up compared to decent gains on the ones to be added. 3 in fact were down on price. It would seem the action has already started. Therefore, I wanted to analyze whether or not traders were already bidding up the CEFs to be added to the index, and/or selling the CEFs to be removed. I also discuss some implications and strategies that investors may take advantage of during CEFL’s rebalancing event. Has the CEFL rebalancing train already left the station? (click to enlarge) Credit: Ben Brooksbank ( some rights reserved ) Fund rotations In my previous article, I presented preliminary lists of CEFs that I predicted were to be added, removed or that will remain in the index. Below are reproduced the same lists except that I’ve arranged the CEFs in order of size, from largest to smallest. The Top 10 CEFs in each category are shown in bold. Added CEFs: RVT (NYSE: RVT ), BCX (NYSE: BCX ), NFJ (NYSE: NFJ ), DPG (NYSE: DPG ), NHF (NYSE: NHF ), DSL (NYSE: DSL ), CEM (NYSE: CEM ), CSQ (NASDAQ: CSQ ), KYN (NYSE: KYN ), CHI (NASDAQ: CHI ), TDF (NYSE: TDF ), USA (NYSE: USA ), NTG (NYSE: NTG ), FEI (NYSE: FEI ), UTF (NYSE: UTF ), BOE (NYSE: BOE ), ETJ (NYSE: ETJ ) Removed CEFs: NCZ (NYSE: NCZ ), NCV (NYSE: NCV ), BGY (NYSE: BGY ), HYT (NYSE: HYT ), CHW (NASDAQ: CHW ), DSL , ETY (NYSE: ETY ), FPF (NYSE: FPF ), VTA (NYSE: VTA ), MCR (NYSE: MCR ), MMT (NYSE: MMT ), EDD (NYSE: EDD ), JPC (NYSE: JPC ), ISD (NYSE: ISD ), EAD (NYSEMKT: EAD ), ERC (NYSEMKT: ERC ), ESD (NYSE: ESD ) CEFs that remain from last year: EVV (NYSEMKT: EVV ), GHY (NYSE: GHY ), EXG (NYSE: EXG ), AOD (NYSE: AOD ), PCI (NYSE: PCI ), GLO (NYSEMKT: GLO ), DSL , AWP (NYSE: AWP ), IGD (NYSE: IGD ), GGN (NYSEMKT: GGN ), FAX (NYSEMKT: FAX ), BGB (NYSE: BGB ), BIT (NYSE: BIT ), HIX (NYSE: HIX ) In this article, I analyze these three groups of CEFs in terms of three metrics: [i] price change, [ii] premium/discount change and [iii] volume change, to see if I could spot any differences in behavior between the three groups. I focus only on the top 10 CEFs in each group for two reasons. Firstly, as those CEFs have the largest weighting in the index, any changes in their price will have a larger impact on CEFL/YYY compared to funds with smaller weighting in the index. Secondly, the higher the allocation of the fund within the index, the more certain I am that that fund is indeed belongs to the category that I have assigned it to. I again wish to stress that all predictions about the CEFs to be added, removed or that will remain in the index are simply predictions, and the actual changes may be significantly different to what I have predicted. For the sake of brevity, however, from this point onwards I will no longer preface my predictions with the word “predicted”. 1. Price change How have the prices of the CEFs fared recently? To analyze this, I plotted the price change of the CEFs over five trading days, from December 21st to the 25th. Top 10 added CEFs RVT Price data by YCharts The graph above shows that out of the Top 10 added CEFs, KYN has the highest 5-day price return of 24.67%, followed by CEM at 13.30%. The average 5-day price return of the 10 CEFs is 7.26%. Top 10 removed CEFs NCZ Price data by YCharts The chart above shows that out of the Top 10 removed CEFs, BGY has the highest 5-day price return of 2.64%, followed by CHW at 1.83%. The average 5-day price return of the 10 CEFs is 1.12%. Top 10 remaining CEFs EVV Price data by YCharts The chart above shows that out of the Top 10 removed CEFs, GGN has the highest 5-day price return of 5.18%, followed by GHY at 3.30%. The average 5-day price return of the 10 CEFs is 2.08%.(Apologies that the above YChart does not appear to be showing correctly. You’ll have to take my word for the numbers). Summary Let’s take stock of the situation. The Top 10 CEFs that were to be added to the index experienced a 5-day price gain of + 7.75% , while the Top 10 CEFs that were to be removed from the index experienced a 5-day price gain of +1.13% . The Top 10 CEFs that remain in the index experienced a 5-day price gain of +1.83 %. Now, the astute reader may observe that two of the Top 10 CEFs to be added (KYN and CEM) are MLP CEFs, which experienced a tremendous rebound over the course of last week. Indeed, KYN rocketed higher by 24.67% while CEM gained 13.30%. Thus, I also calculated an “ex-MLP” average for the remaining 8 CEFs to be added. The answer came out to be +4.33% , which is still significantly greater than the other two categories of CEFs. The above data would support the notion that the CEFs to be added experienced buying pressure while the CEFs to be removed experienced substantially less buying pressure over the past 5 days. 2. Premium/discount change Perhaps a better way to determine buying and selling pressure on CEFs is to study changes in premium/discount value, because the premium/discount value reflects how much more (or less) investors are willing to pay for a CEF compared to its net asset value [NAV]. The following graphs show the change in premium/discount value for the CEFs over the period of last week, from December 21st to the 28th (source: CEFConnect ). Top 10 added CEFs The graph above shows that KYN experienced the largest increase in premium/discount at +4.54%, followed by TDF at +2.41%. 9 out of 10 CEFs to be added experienced positive gains in premium/discount value, while only NFJ had a slightly negative loss of -0.10%. The average of the 10 CEFs was +1.62%. Top 10 removed CEFs The chart above shows that HYT experienced the largest premium/discount increase at +1.52%, followed by VTA at +0.22%. However, 6 out of 10 CEFs experienced decreases in premium/discount value, with MCR and MMT both declining by -1.51%. The average of the 10 CEFs was -0.46%. Top 10 remaining CEFs Of the 10 remaining CEFs, GLO had the highest premium/discount increase of +1.42%, while DSL had the lowest premium/discount change of -1.90%. The average of the 10 CEFs was -0.02%. Summary The Top 10 CEFs that were to be added to the index experienced a 1-week premium/discount change of +1.62% , while the Top 10 CEFs that were to be removed from the index experienced a 1-week premium/discount change of -0.46% . The Top 10 CEFs that remain in the index experienced a 1-week premium/discount change of – 0.02% . The above data would support the notion that the CEFs to be added experienced buying pressure while the CEFs to be removed experienced slight selling pressure over the past 1 week. 3. Volume changes Volume changes can reveal unusual buying or selling pressure on individual CEFs. The below graphs show the changes in 30-day average daily volume for the CEFs over the past one month. I used the 30-day average daily volume rather volume to reduce the effect of volume spikes and make the data more easy to visually interpret. Top 10 added CEFs RVT 30-Day Average Daily Volume data by YCharts The Top 10 CEFs added averaged a +67.73% increase in 30-day average daily volume over the past month. Top 10 removed CEFs NCZ 30-Day Average Daily Volume data by YCharts The Top 10 CEFs removed averaged a +42.00% increase in 30-day average daily volume over the past month. Top 10 remaining CEFs EVV 30-Day Average Daily Volume data by YCharts The Top 10 CEFs remaining averaged a +41.11% increase in 30-day average daily volume over the past month. Summary The Top 10 CEFs that were to be added to the index experienced a 30-day average daily volume increase of +67.73% over the past month, while the Top 10 CEFs that were to be removed from the index experienced a 30-day average daily volume increase of +42.00% . The Top 10 CEFs that remain in the index experienced a 30-day average daily volume increase of +41.11% . The above data would support the notion that the CEFs to be added experienced buying pressure over the past 1 month. However, the volume of the CEFs to be removed was not significantly greater than that for the remaining CEFs (the control set). Discussion of results In this study, I compared the 5-day price change, 1-week premium/discount change and 1-month 30-day average daily volume change for three groups of CEFs. The first group were the Top 10 CEFs by weighting that I predicted were to be added to the index. If frontrunning of the index were to occur, this group would experience buying pressure before the rebalancing date. The second set were the Top 10 CEFs by weighting that I predicted would be removed from the index. If frontrunning were to occur, this group would experience selling pressure before the rebalancing date. The final group were the Top 10 CEFs by weighting that I predicted would remain in the index. While these CEFs may change in weighting depending on whether their relative allocations were to be increased or decreased, I still used this group as a control set because I would expect the increases or decreases to partially offset each other. The characteristics of the three groups are presented below. Top 10 added CEFs: +7.75% ( +4.43% ex-MLP) price change, +1.62% premium/discount change and +67.73% volume change. Top 10 removed CEFs: +1.13% price change, -0.46% premium/discount change and +42.00% volume change. Top 10 remaining CEFs: +1.83% price change, -0.02% premium/discount change and +41.11% volume change. Now, readers may draw their own conclusions from the data, but it is clear to me that the frontrunning may have already begun. Both the price and premium/discount data support this idea across three data sets. The volume data indicates higher buying pressure among the added CEFs, although the volumes of the removed CEFs and the remaining CEFs were similar. What are the implications for investors? If this frontrunning behavior were to continue, there are a number of possible strategies for investors depending on the time frame: Sell CEFL or the CEFs to be removed now. While the CEFs to be added have already shown significant increases in price, the CEFs to be removed have not yet experienced heavy selling. Last year, the top 10 CEFs to be removed declined by -3.38% in the one week before the rebalancing date. If further selling in these CEFs were to occur, CEFL will decline in value. Sell the added CEFs just before rebalancing . A number of the CEFs to be added showed increases in both price and premium/discount values. If these were to revert after rebalancing, then those CEFs will decline in value. The best time to execute this strategy may be just before the rebalancing is to take place. Buy the removed CEFs after the rebalancing. Frontrunning may cause the prices and premium/discount values of the removed CEFs to be artificially depressed in price. This might make these funds good buys after the rebalancing is complete. I close by repeating again that my list of CEFs are simply predictions of the upcoming changes and the actual changes may be materially different to my predictions. A final cautionary note is warranted, as presented by reader cpyles42 : Furthering your cautionary note for all the amateur front runners – if UBS has already front run, they will simply cross their positions at rebalance, book a nice profit for themselves and the buying/selling that everybody is expecting to emerge to get them out of their front run positions at the beginning of the year will be absent. if enough people front-ran you could even see a paradoxical response, this happens all the time in markets because market positioning if often the most important short-Term factor. I have provided the 5-day price changes for all the CEFs in each of the three groups for further consideration by readers, in order of largest to smallest price change. 16 added CEFs (click to enlarge) 16 removed CEFs (click to enlarge) 14 remaining CEFs