Closed-end funds (CEFs) may be a small fraction of the asset management industry, but to family-run boutique Thomas J. Herzfeld Advisors, they are everything.
Thomas Herzfeld and his son Erik run the Virtus Herzfeld fund, a fund of CEFs. The $60 million fund is ranked seventh out of 137 funds in Citywire’s Mixed Portfolio category, thanks to three-year total returns of 22.1% versus the average fund’s 7.6% at the end of February. The duo are AAA-rated for their risk-adjusted returns too.
The Herzfelds seek out those funds with shares trading at a discount to the strategy’s underlying net asset value, which they believe will rally to close this gap, netting them a tidy profit.
‘We are like fund of fund managers but are really stock traders,’ Erik says. Their flagship fund is contrarian in nature and uses a combination of technical, quantitative and qualitative analysis to seek out undervalued CEFs. Although they will assess a fund on 20 qualities, which will be familiar to most fund analysts, before investing, Erik Herzfeld says 50% of the decision is based on the discount on offer.
‘We will get into a fund with the idea that there has to be a catalyst that the discount will narrow,’ he says. ‘If there is a fund that is always at a premium and it goes to any type of discount, that is always quite interesting to us. It doesn’t have to be a wide discount. There are lots of funds that have had a wide discount for many years and they never narrow. We are not interested in those.
‘The ones we are interested in are those that are going to start narrowing.’ For example, CEFs run along the same lines as more well-known mutual or hedge funds, but which fall to a discount, such as the Pimco Dynamic Credit and Mortgage Income fund.
‘When Bill Gross left Pimco, people's jaws dropped and they left [the CEFs], but most of the funds weren’t actually managed by him but by Dan Ivascyn and Alfred Murata. A couple of funds we loved went down 5% that day because everyone thought Gross leaving was terrible,’ Erik says. ‘Conversely, when [former Fed chairman] Ben Bernanke went to Pimco as an advisor, a lot of funds went up 2%. So there was a 7% swing based on nothing.’
Backing the underdog
Erik worked as a trader at JPMorgan, and his sister Brigitta, who is managing director of the firm, worked at Goldman Sachs, before joining their father’s business. ‘He was really anti-nepotism,’ she says. ‘We always wanted to work for our father because he pioneered a lot of this, but he said: “go out and make all your mistakes somewhere else”.’
Erik likens investing in CEFs, which account for around $300 billion versus mutual and exchange-traded fund’s $18 trillion, to betting against the favorite.
‘If you are cynical all the time, and looking to back the underdog, then this is the place for you. CEF investing is similar to that. You have to look at a fund when it is at a discount and see things in it that other people don’t.’
Although highly focused on trading, the firm is cognizant of the wider macro picture and aware of the need to diversify, aiming for a 60/40 split between equities and bonds, either way round. It is currently 50% equities, 35% fixed income, with 15% in cash to take advantage of buying opportunities.
The fund recently put cash to work on a typically contrarian call on healthcare before the election last year. ‘All the big healthcare names were being pushed down because of comments by Hillary Clinton and all the closed-end funds, such as the Tekla Healthcare Opportunities fund, were pushed down too so you got a discount on a discount,’ Erik says.
‘Our mentality was: if she wins, it is priced in. But, what if Trump wins? If he does, it goes crazy up. We loaded up on healthcare. ‘We can’t predict the future, but you can get rewarded for taking the other side.’