Closed-End Bargains Beckon
Bruises from the market's big punches are still evident on closed-end funds. Unlike regular mutual funds, closed-ends issue a set number of shares and trade like stocks on exchanges. Closed-ends' share prices have been about two to five times as volatile as their underlying assets during the recent market turmoil, says Gregory Neer, an analyst with Stifel Nicolaus, an investment firm.
The share price of a closed-end fund can sell at premium or discount to the net asset value per share of the fund's own holdings. Usually, closed-end funds trade at a small discount to their NAV (you can see this at Web sites such as www.etfconnect.com and www.amex.com. During the past five years, these discounts have narrowed or disappeared as investors snapped up the high dividend yields offered by many closed-ends.
But recently the spreads expanded dramatically during the market sell-off. The median discount for all closed-end funds was 6.5% as of August 20, according to Lipper, a fund research firm. That's more than triple the median discount of 1.8% on May 31.
This move in the discounts has been so quick that Neer calls the selling spike "irrational." The way he sees it, "Investors have been selling their closed-end fund holdings without regard to valuation, yield or fundamentals of the underlying assets." You could say that about the stock market in general, but you see the effects twice when you own closed-end shares.
Alert or brave buyers have already scooped up some of the low-hanging fruit. For example, on August 17, Eaton Vance Tax-Advantaged Global Dividend Income Fund (symbol ETG) -- which invests in dividend-paying stocks in the U.S. and Europe -- traded at a 14.9% discount, its widest since September 2005. By August 22, the discount was 7.5%. In bright green terms, the price of each share of ETG went from $23 to nearly $26 -- much more dramatic recovery than the general stock indexes.
Although deep discounts like this aren't as obvious even after one week of relatively normal stock trading, opportunities still abound. Neer cites Dreman-Claymore Dividend & Income (DCS), which yields 5.7% and sold at an 11.8% discount as of August 22, which is wider than its average discount for 2007 of 10.1%, according to Morningstar. The fund began this year at a 6% discount, so if it piques wider interest, that discount ought to narrow some more. Since August 16, the shares are up 6.5%, so there's no reason why not.
David Dreman, who manages the fund, is one of the best-known contrarian investors. He buys widely despised stocks such as Fannie Mae and Pfizer and waits for the market to recognize their value. "Dreman's deep-value strategy tends to do very well in this type of choppy market," Neer says. Plus, his strategy is better suited to a closed-end fund anyway than a traditional open-end mutual fund. Fittingly, DCS has a better three-year performance record than open-end Dreman Contrarian Large-Cap Value fund.
For income in a closed-end fund, Morgan Stanley analyst Paul Mazzilli recommends Fiduciary-Claymore MLP Opportunity (FMO). It invests almost 80% of its assets in master limited partnerships that own oil and gas pipelines, a source of steady growth and reliable dividends. Mazzilli favors the fund for its yield of 6.4%, which is among the highest of funds that invest in master limited partnerships. Over the past year, the fund's shares have returned 22%. The fund trades now at an 11.5% discount, much wider than the long-term average of 4.5%. The fund started 2007 at a small premium. This wide discount is curious because pipeline stocks have done well and aren't particularly sensitive to scary goings-on in the overall stock and bond markets.
Closed-end funds also are a better way to invest in emerging markets than are open-end funds. Again, the managers of closed-ends don't have to suffer with forced buying or selling in response to investor emotions. This is particularly helpful because many securities native to developing countries aren't terribly liquid -- that is, they aren't easy to trade at good prices.
Templeton Emerging Markets (EMF) is a trailblazer in this volatile category. Mark Mobius has run the fund since 1987, supported by a staff of analysts across the globe. Top holdings include Brazilian global energy companies Companhia Vale do Rio Doce (RIO) and Petroleo Brasileiro, or Pertobras (PBR) as well as Aluminum Corp. of China (ACH). For five years to August 22, EMF's shares returned an annualized 30%, beating the average diversified open-end emerging markets fund by 12 percentage points a year.
Templeton Emerging Markets gained a remarkable 13% in one week from its August 15 trough, but it still has a 9.3% discount, which is close to its 2007 average.