Back in early 2006, my Foolish colleague Rick Munarriz introduced the concept of investing in closed-end funds at a discount to net asset value (NAV). Thesetwo articles provide all the additional background you could desire. The key concept here is that closed-end funds, unlike standard open-end mutual funds, trade in the secondary market, opening up the possibility of a divergence between a fund share's price and its value.
If you've been dreaming of buying a mutual fund on sale, well, you might need to get out more. Nevertheless, you're in luck, because closed-end funds afford exactly such an opportunity.
Take Rick's example of Tri-Continental. At the time, the fund was trading at a 13% discount to its NAV. This year, that gap has narrowed to roughly 7%, thanks to some good old-fashioned shareholder activism. That narrowing translates to some seriously outsized year-to-date results -- an 8.4% market return versus a modest 1.1% NAV return.
As of Monday, here are the six steepest discounts on closed-end funds with more than $250 million in assets:
|
Fund |
Asset Class |
Discount to NAV |
5-Year Avg. Premium/Discount |
5-Year NAV Annualized Return |
|---|---|---|---|---|
|
Morgan Stanley China A Share Fund |
Chinese equities |
(23%) |
N/A |
N/A |
|
Western Asset Emerging Markets Debt Fund |
Emerging market fixed income |
(14.4%) |
N/A |
N/A |
|
ASA Limited |
Gold equities |
(14.8%) |
(10.6%) |
19.3% |
|
Adams Express Company |
Equities |
(13.8%) |
(13%) |
10.8% |
|
Dreyfus High Yield Strategies Fund |
Fixed income |
(14.1%) |
1% |
16.2% |
|
Morgan Stanley Asia-Pacific Fund |
Asia-Pacific equities |
(14.5%) |
(12.4%) |
21% |
Less Asian contagion ...
When I ran this list three months ago, three China funds perched atop the sale rack. Morgan Stanley's A-share fund once again leads the list, albeit with a slightly narrowed discount. The firm's Asia-Pacific fund now joins its narrowly focused neighbor. This newcomer is actually a veteran among the ranks of discounted closed-end funds -- you can see that it has averaged a double-digit discount to NAV over the past five years. If you're looking for simple mean reversion, this fund is not likely to reward your immersion. But if you like the idea of swiping a discounted basket of Pacific powerhouses like BHP Billiton, Nintendo, and Toyota in Yogi Bear-like fashion, then I can certainly see the appeal.
... more credit contagion ...
The recent credit crunch has introduced a swath of high-yield fixed-income funds to the divergence doghouse. Western Asset Management has surveyed the lay of the land, and it looks so hairy out there that the firm has elected to modify the investment policies governing its Emerging Markets Debt fund.
The firm will now have more flexibility to invest in investment-grade securities. It's also recently boosted its dividend yield by 37%, citing long-term capital gains that are available for regular distributions to shareholders. These two steps demonstrate a lot of confidence in the fund's viability, and I'm eager to see how the new policies influence the discount going forward.
Another debt daredevil is the Dreyfus fund, which presently pays out a hearty 9% dividend yield. Unlike most funds that crop up in the bargain bin month after month, this one has actually traded at a slight premium to its NAV over the last five years. Before anyone gets too excited about the prospect of this fund snapping back to parity, consider why investors might be unwilling to pay full price for the stated value of this fund's junk bonds. We're just now coming off record low credit spreads -- the amount of compensation demanded by a fixed-income investor to buy riskier debt. In my view, there's a lot of room for these fixed-income assets to fall as fear grabs remaining bond bulls by the horns.
... and a fund that keeps on aging
Adams Express is an interesting fund that I've given the ol' green thumb in Motley Fool CAPS. Much like American Express, Adams was founded as an express delivery company in the 1850s. After exiting the railroad business, the firm transformed itself into an investment manager at the peak of closed-end fund mania in 1929. The fact that Adams has stuck with the fund management business ever since demonstrates some serious staying power.
At first glance, the fund appears similar to your dime-a-dozen large-cap fund, with top holdings like Microsoft, Bank of America, and Pfizer. But there's this strange thing sitting at the top of Adams' holdings -- something called Petroleum & Resources
Like a Russian matryoshka doll, Adams Express has nested within it another closed-end fund. And guess what? It, too, is trading at a double-digit discount. Actually, it's at 9.4% now -- thus continuing a steady whittling over the past year or so. Whether Petroleum & Resources, which is managed by the same people, will help Adams Express escape its discount rut, I cannot say. But the odds do seem to be in the investors' favor, considering the double-double discount at work.
For further related Foolishness:
Bank of America is an Income Investor selection. Both Microsoft and Pfizer are Inside Value picks. Nintendo is a Stock Advisor recommendation. We'll beat a double-digit discount -- you can check out any newsletter free for 30 days.
Fool contributor Toby Shute doesn't own shares in any company or fund mentioned. The Motley Fool's disclosure policy is contagious -- like laughter, not the common cold.
