With the recent collapse in the stock market, you're hearing lots of advice telling you to buy stocks at bargain prices. For one special type of investment, though, you can get a discount two ways, and that can add up to some real savings.
Closed-end funds aren't the best-known investment out there. But thanks to the peculiar way in which closed-end funds work, smart investors can buy shares that are especially cheap after the broad market's swoon.
Why closed-ends give you a double discount
If you've looked at your portfolio lately, you've probably noticed that just about everything is down. So by that measure, you can pick up shares of almost anything at a discount compared with where prices were a month or two ago.
But the secret of the double discount in closed-end funds comes from their unique structure. As with exchange-traded funds, you can buy or sell shares of closed-end funds on the stock exchanges anytime the market is open. But unlike ETFs, closed-ends have a fixed number of shares outstanding, which leaves them susceptible to changing supply and demand conditions in the market.
During sharp market downturns like the ones we've seen in recent weeks, many closed-ends see their investors run for cover. Because those investors are willing to sell shares for whatever they can get on the open market, closed-end fund shares often trade at substantial discounts to the actual value of the assets the funds hold, also known as their net asset value.
Go anywhere with closed-ends
The nice thing about closed-end funds is that, as with mutual funds, you can take your pick from a broad range of asset classes they cover. From regular stock funds to sophisticated derivative-investing vehicles, from publicly held securities to closely held corporate investments, closed-ends exist to give you the exposure you want.
But perhaps the best discounts come from the least exciting funds. Lots of plain-vanilla closed-end funds that own some of the safest blue-chip stocks find themselves at impressive discounts right now. Here's a sampling:
Boulder Total Return has a huge chunk of stock in Berkshire Hathaway
(NYSE: BRK-A) (NYSE: BRK-B). Despite the liquidity of Warren Buffett's investment vehicle, the fund's discount recently widened to 21%.
Royce Value Trust
(NYSE: RVT)is a proven market-beater that has put up some impressive performance over the years. Focusing mostly on small caps, you'll find Ritchie Bros. Auctioneers and Rofin-Sinar Technologies (Nasdaq: RSTI)contributing to the closed-end's returns.
- Two stalwarts in the closed-end space, Adams Express
(NYSE: ADX)and Petroleum & Resources (NYSE: PEO), are also seeing significant discounts. With energy and commodities falling out of favor, Petroleum & Resources has seen its share value drop recently in line with both oil giants and resource plays like Freeport-McMoRan Copper & Gold (NYSE: FCX), but the closed-end has also picked up a wider-than-average discount. On the other hand, Adams Express has a broader investing mandate, combining a slug of Petroleum & Resources along with a bunch of top blue chips from other industries.
Now just because discounts to net asset value are wide right now doesn't mean you'll get an immediate payoff. During the market meltdown in 2008 and 2009, discounts to NAV stayed wider than normal for months. Moreover, with many funds, discounts will never disappear entirely.
But two things favor buying closed-ends at a discount. First, the dividends these stocks pay aren't discounted, so by paying less for shares, you can get a higher yield based on your investment. Second, when it comes to capital appreciation, getting in when discounts are high is more likely to give you strong returns on your closed-end investment.
You'll also want to watch out for high fees on closed-end funds. Some closed-ends take advantage of their captive investing audience by imposing fees that greatly exceed typical ETFs and mutual funds. Boulder Total Return, for instance, charges more than 2% all told, but Royce, Adams Express, and Petroleum & Resources have much more modest annual expenses.
Closed-end funds can be tricky, especially because they often trade relatively few shares. They're not safe for short-term traders, but if you're willing to commit for the long haul, the values they offer can boost your profits over time.
Closed-ends are just one way that buying funds on stock exchanges can make you money. Learn about some promising ETFs in this special free report, "3 ETFs Set to Soar During the Recovery," and get back on the road to riches.
Fool contributor Dan Caplinger likes discount investments. You can follow him on Twitter here. He owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and Rofin-Sinar Technologies. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway, Ritchie Bros. Auctioneers, and Rofin-Sinar Technologies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is there for you whatever time it is.