The recent peculiar trading in the New Ireland Fund (NYSE: IRL), a closed-end fund, illustrates an important point for international investors who turn to CEFs for individual country exposure around the globe.
CEFs are not like open-ended mutual funds or exchange-traded funds (ETFs). A regular mutual fund has a manager who chooses which stocks to buy, like a CEF. But when new investors want to buy the fund, a mutual fund can go out and buy more stock with those funds, increasing its assets under management.
CEFs have a fixed amount of shares outstanding. Investors who want to own the fund have to buy existing shares from other investors who sell their shares. So a CEF trades on an exchange, just like other listed stocks. That means the price can move up or down very quickly, if more people want to buy than sell at a given moment.
That's where CEFs differ from ETFs. The latter mirror an index in the U.S. markets or a foreign index; they will always be priced to reflect that index. Individual investors can't drive them up or down with their own buying and selling.
CEFs have two important numbers: the share price where the CEF last traded, and the net asset value (NAV), the actual value of all the stocks and cash the fund holds. Speculative buying by investors can drive the share price higher than the NAV, creating a "premium" in the CEF. They can also drive the share price lower than the NAV with a lot of selling, creating a "discount."
Most CEFs trade at a small discount to their NAV, for many reasons. The New Ireland Fund is usually no exception; from January until November, it carried a 4%-11% discount to NAV, even while the share price moved up smartly from $23 to $33. The Irish stock market had a great year, and so did the New Ireland Fund.
The weird part came in late December, when average daily volume in the fund shot from 10,000-15,000 shares per day to 100,000 or more. The share price leapfrogged the NAV and traded at almost 10% more than the NAV price, a sharp premium.
Why? I can only guess that a mutual fund somewhere wanted to use the New Ireland Fund for "window dressing," a game where funds buy a successful stock right before the end of the quarter so they can show their investors that they own winning stocks. While the practice is less than honest, it is not illegal, and it happens all the time.
Once the quarter ended and trading began in early January, either other New Ireland Fund owners saw the premium and quickly sold for an easy profit, or the window-dressers quickly reversed their positions. Either way, the Foolish lesson is to be very wary when you see CEFs trading at a premium to their NAV. Chances are it won't last for long. When you're shopping for international CEFs, stick to the discount bin.
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Fool contributor Dale Baker, a private client portfolio manager and former U.S. diplomat with extensive experience in Europe and Africa, owns shares in the New Ireland Fund for himself and his clients, and dreams about owning a quaint Irish farmhouse one day. He welcomes your questions or comments at dabmu@yahoo.com. The Fool has a disclosure policy.
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