The past few weeks have been an extraordinary period in the markets, and have certainly tested the discipline of even the most long-term investors. It is our hope that yesterday, October 13, the Dow's largest daily point gain in history, is the beginning of calmer markets. We recognize that many investors are extremely apprehensive about the recent performance of the Calamos closed-end funds in these turbulent times; and we would like to take this opportunity to address some of these concerns.
Panic has taken hold …
Frozen credit markets, recessionary concerns, bank failures, and deleveraging have fuelled a widespread and severe retreat across asset classes. Stocks, bonds and convertible securities have all been caught in this ferocious downdraft. In this environment, closed-end funds—including the five Calamos closed-end funds—have fallen sharply, with shares trading at significant discounts to net asset value.
… but fundamentals and valuations are compelling, by and large
When we analyze what's happening in the market, we're seeing a case of fear and liquidity requirements outweighing existing fundamentals and valuations. Market participants have succumbed to panic, and even sound investments are being sold off. Of course, there are other more tangible factors at play as well. For example, hedge funds (many of which were carrying relatively high levels of leverage) aggressively deleveraged their portfolios to meet margin requirements. As a result, the market has experienced significant sell-offs resulting in negative valuations of convertible securities and high-yield corporate bonds, asset classes in which the Calamos closed-end funds invest.
Against the current backdrop of frenetic deleveraging and poor liquidity, the prices of many convertible and high-yield securities have fallen well below what we feel is their fair value. In particular, we're seeing valuations in the convertible market that we have never seen before. Convertibles declined in value similar to the underlying common stocks, creating valuation gaps well below our fair value estimates. In the past, the valuation gap corrects itself as volatility returns to a calmer level. Therefore, for longer-term investors looking beyond this current crisis, we believe these current conditions may present an opportunity. (To learn more, please read our special report on convertible market conditions.)In addition, the discount level of net asset value to market price has widened to levels that we have never seen in the history of the Calamos closed-end funds.
What about the leverage in Calamos closed-end funds?
More often than not in today's market, "leverage" has become inextricably tied with additional risk. Closed-end funds—including ours—use leverage. However, they are limited by federal securities law and by prospectus as to the amount of leverage they can employ.
Through the life of the Calamos closed-end funds, leverage has been accretive to the common shareholders. The cost of leverage has been less than the yield and dividends levels of the portfolio, allowing the funds to pay a higher distribution to shareholders. Because of the recent market volatility and the problems with the auction rate preferred securities market, we have engaged in moderate deleveraging of the Calamos closed-end funds to ensure compliance with the Investment Company Act of 1940 and the funds' prospectuses.
What should investors do?
We understand that many investors may be tempted to give in to panic. However, decades of experience has taught us that making decisions in a panic is never a good idea. Instead, consider the longer-term—both the longer-term performance of your investments and your longer-term goals.
It's important to remember that closed-end funds are long-term investments. The majority focuses on providing monthly distributions, but there are important differences among individual closed-end funds. Calamos closed-end funds can be grouped into two broad categories:
Enhanced Fixed Income—portfolios positioned to pursue high current income, and to a lesser extent, capital appreciation
Total Return—portfolios positioned to seek current income, with increased emphasis on capital appreciation
(Click on a Fund's name for long-term performance, distribution history and portfolio characteristics.)
How will the markets get through this?
No one can predict the exact timing and the precise catalyst that will restore sanity to the markets. As I mentioned, I don't believe that deteriorating company fundamentals are the root cause of the turmoil. I believe the current bank panic is the result of a lack of government action and inappropriate regulation. As such, I believe government action will be required to right the markets' course. I do think that sensible steps are being taken—and I support Congress' decision to approve the bailout plan, the Fed's continued efforts to inject liquidity into the markets, and the coordinated actions of the Fed and other world central banks.
I remember periods in the mid-1970s and early 1980s—times when the markets and economy were facing unprecedented turmoil, and seemingly insurmountable odds. Yet, the markets ultimately regained their traction and brought considerable long-term opportunities for prosperity. I believe the same holds true even today. All of us at Calamos Investments remain committed to pursuing this opportunity on behalf of our closed-end fund shareholders.
In times like these, I encourage you to stay in touch with your financial advisor, and remember that our Client Services Team is also available to help you.
John P. Calamos, Sr.
Chairman, CEO and Co-CIO
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
Information about Risk:
Shares of closed-end funds frequently trade at a market price that is below their net asset value.
Each Calamos closed-end fund has announced the adoption of a level rate distribution policy. Under this policy, the Fund, subject to market conditions at the time of declaration, will pay monthly distributions on each common share. Please visit www.calamos.com for more information on each specific fund.
Leverage: Leverage creates risks which may adversely affect return, including the likelihood of greater volatility of net asset value and market price of common shares; and fluctuations in dividend rates on preferred shares.
Lower-rated securities: Investments by the Fund in lower-rated securities involve substantial risk of loss and present greater risks than investments in higher rated securities, including less liquidity and increased price sensitivity to changing interest rates and to a deteriorating economic environment. Fixed-income securities are subject to interest-rate risk; as interest rates go up, the value of debt securities in the Fund's portfolio generally will decline.
Convertible bonds: There are certain risks associated with an investment in a convertible bond such as default risk—that the company issuing a convertible security may be unable to repay principal and interest—and interest rate risk—that the convertible may decrease in value if interest rates increase.
Foreign securities (CGO and CHW): The Fund may invest up to 100% of its assets in foreign securities and invest in an array of security types and market-cap sizes, each of which has a unique risk profile. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities. These include fluctuations in currency exchange rates, increased price volatility, and difficulty obtaining information.
Derivatives (CGO): The Fund may invest in derivative securities, including options. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. There is no assurance that any derivative strategy used by the Fund will succeed. One of the risks associated with purchasing an option is that the Fund pays a premium whether or not the option is exercised.
Derivatives (CHW): The Fund may invest in derivative securities, including options and swap agreements. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. There is no assurance that any derivative strategy used by the Fund will succeed. One of the risks associated with purchasing an option is that the Fund pays a premium whether or not the option is exercised.
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