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January, 2013

TROLLING FOR VALUE AMONG CLOSED-END FUNDS
by LARRY

Where few venture in the investing world, there may be nuggets waiting to be snatched up. It has been suggested by various authors that closed-end funds might be a profitable niche for such a quest. Closed-end funds (CEFs) trade in the public markets like stocks but are mutual funds that typically invest in equity securities and/or in debt instruments. Having a set number of shares, unlike open-end mutual funds, their prices rise or fall depending on the relative prevailing "winds" of market bias for or prejudice against them. For the value investor, this sometimes whimsical variability of their market prices can give closed-end funds either a disadvantage or an advantage, popular notions of an asset's worth not always being consistent with net asset value (NAV). Thus a CEF may be priced higher than (or at a premium) to its NAV, in which case it's suspect as a value investment but might be a good security to "sell short," betting that its price will go down. On the other hand, it might very well be in disfavor for reasons not commensurate with its true per share assets less debts (NAV), in which case buying it can be like getting $1.00's worth of value for only 80 or 90 cents or so.

It is a little tricky, though. For diverse reasons, CEFs tend to sell for a little less than their NAV, and waiting for them to achieve full value may be a loser's game. If one is to succeed as a value investor in CEFs, he or she needs to buy these financial instruments when they are selling at below average discounts and yet when they retain at least reasonably good prospects. The strategy works in an investor's favor because unusual closed-end fund price to net asset value discounts tend to return to their average levels.



I am certainly not an expert at this kind of investing, but the majority of the several times I have taken the plunge with CEFs I have made money. In my view, it is best, as I say, to buy shares in such a fund when the NAV is not only higher than its market price but also when the discount is higher than average (over say the last 5-10 years). I also like to look at what one or more investment rating agencies say about the asset in question and of course prefer that they be positive on it. Generally it also seems best to me if the managers of the fund do not charge exorbitant fees and do not engage in much leveraged or debt-based investing to pump up their returns, fine in up markets but hazardous in down ones. A trusted closed-end fund manager, however, with a good long-term record, may have provided excellent performance so that one feels the added risk is worthwhile.

If you find this type investing intriguing and, like me, feel like experimenting with it, there are no guarantees, and I do recommend that one do his or her own research, but these are five closed-end funds of particular interest for me at the moment.



Low P/NAV Closed-End Funds

Closed-End FundStock
Symbol		Recent
Price		P/NAV
Discount		Average
Discount		Income
Only
Yield		Management
Fees
Boulder Total Return Fund, Inc.BTF$19.0920.59%16.93%0.18%1.91%
Eaton Vance Enhanced Equity Income Fund IIEOS$10.9111.44%4.35%0.25%1.00%
First Opportunity FundFOFI$7.8023.75%18.86%0.00%0.85%
India Fund, Inc.IFN$21.7211.35%4.93%0.00%0.97%
Morgan Stanley IndiaIIF$18.9010.68%5.90%0.00%1.14%
(Info is based on 1/17/13 values.)

For verification of CEF stats I recommend the Closed-End Fund Association - CEFA.



It does seem better to invest in several CEFs at once, since the risk of an entire portfolio going south is much less than with just one or two closed-end funds at a time. Also I suggest holding such securities till the original discount to NAV has been reduced by 5% or more. Since a worthwhile closed end fund will see its net asset value rise over time, this usually means a bigger advance from the initial investment cost than simply 5%.

On the other hand, if one is not very familiar with closed-end funds and that 5% reduction in the discount has not already happened, I would also recommend switching to a lower price to net asset value (P/NAV) CEF (that meets the buy criteria) when the first of these occurs: either the price is up 50% or the asset has already been held for two years and yet no longer meets one's buy criteria. With dividends (which some but not all CEFs have) thrown in, I believe one is likely to better the market with this type strategy and with a little less risk of loss of principal.



One advantage some investors see in a low price to net asset value approach is that one need not have a really large portfolio, 25 or 30 assets for instance, and need not monitor it as closely as might be the case with individual stock securities. 5-10 are probably plenty if chosen well, and one can simply leave them alone for 3, 6, or even 12 months, then weed out those which have gone up enough, have sufficiently reduced discounts, and/or have been held for a couple years, replacing them at that time with new bargain CEFs.

Occasionally the market as a whole will be high enough that one cannot find qualifying CEFs. This is a danger signal, a good time to avoid new investments and instead to reduce holdings somewhat and increase reserves, for a significant market pullback may not be far behind.

Another technique that is useful may be to merely keep a good allocation in different asset classes, for instance a 5% investment in money market funds, 35% in global income funds, and only 60% at first invested in closed-end stock funds. Then if one's desired allocation gets skewed by more than 10% one way or another, sell shares in the class of assets which has too much and buy more of any which have too little, in order to bring the portfolio back into the desired alignment, in the process selling some shares higher and buying others lower. If for some reason when it is time to buy more stock funds using this method there are not enough qualifying CEFs, make up the difference for the time being with exchange traded funds (ETFs) (index funds that trade like stocks) rather than compromising one's CEF buy criteria.



At times it is helpful to try out new techniques with hypothetical portfolios. Folks completely unused to CEF investing might first take on approaches such as described above on one of the investor support websites that track assets' performance and dividends, yet without actually buying them till sure one can do well.

In any case, good luck with developing skills in value investing. Over the long haul, they can be quite lucrative and definitely need not involve great risk.



DISCLAIMER

Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)



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