Most closed-end funds dwell in relative obscurity. After the funds are launched, sponsors spend no money to market them and brokers don't promote them to clients. And that's a pity because there are many excellent closed-end funds, and many that invest in stocks are selling at prices well below the value of their holdings.
Closed-end fund sponsors, such as BlackRock and Nuveen, sell a fixed number of shares to the public and invest the proceeds. The funds then trade just like stocks. Their market prices can -- and do -- stray widely from the values of their underlying portfolios. This market inefficiency can create buying opportunities when the funds sell at sharp discounts to their net asset value (NAV) per share, as many of them do now.
The closed-end-fund format also offers some advantages to fund managers. They don't worry about redemptions or big inflows of new cash, so they can focus on long-term results and put every penny to work. They can hold less-liquid securities, such as stocks of tiny companies.We've chosen six of the best closed-end stock funds. All trade at discounts to NAV, have performed handsomely over the years and are run by seasoned managers. For details on performance, discounts and expenses, click on the companies symbols throughout the story.
An oldie but goodie
Spencer Davidson regards the stability of the closed-end format as vital to the stunning success of General American Investors (symbol GAM). He can invest in unpopular stocks without fear of losing assets because of near-term bumps. Exercising patience and looking beyond the horizon, he says, are key to generating superior long-term returns.
General American, established in 1927, is an independent, internally managed closed-end fund. That means the management shop's sole task is to run General American. From the time Davidson took the helm in August 1995 to May 12, the fund returned an annualized 15% on its assets -- an average of six percentage points per year ahead of Standard & Poor's 500-stock index. Davidson, aided by a team of six analysts, focuses on stocks of large, growing companies selling at reasonable prices. He keeps portfolio turnover to 20% or less per year.
Davidson is bearish on the prospects for the U.S. economy: He expects a longer and deeper economic slump than most pros do. But that's one reason he likes discount retailers, such as Costco Wholesale and TJX Cos., which operates discount clothing chains TJ Maxx and Marshalls. "When consumers are stretched, they trade down on prices," he says.
Davidson is also pouncing on companies with considerable overseas exposure, particularly those tied to surging demand from emerging markets for infrastructure and commodities. He made Cemex, a global cement giant, a large holding after he met with and gained confidence in the Mexican company's executives. He has gradually lightened the fund's holdings in energy-exploration and production companies and added positions in service providers, such as Weatherford International. "I don't know the right price of oil, but I'm confident service companies make money whether it's $120 or $60," Davidson says.
Buying assets, selling earnings
Like General American, Central Securities (CET) is a company that does only one thing: run a closed-end fund. The primary difference is that Central, founded in 1929, invests in companies of all sizes. Wilmot Kidd, who has run this fund since 1973, prefers smaller companies he reckons have plenty of room to blossom and grow. His fund's "permanent capital," as he describes shareholders' money, grants him the luxury to look out three to five years when he invests and to sow seeds in illiquid securities, such as shares of privately held companies.
Kidd describes his investment method as buying assets and selling earnings. In other words, he buys businesses whose value isn't recognized by the marketplace and sells when the market catches on. He stresses that he's a fractional owner of real businesses, not a trader of paper, and that he has little time for investment style boxes. "Value and growth are a false dichotomy," he says.
When Kidd says he's a long-term investor, he means it. He's held shares of Murphy Oil since 1974, and he's ridden the rise of Intel since 1986. His largest holding is Plymouth Rock, a privately owned insurer that has returned 20% a year since he first invested in it, in 1982. Kidd also likes small industrial firms, such as Dover and Roper, that are generating strong cash flows.
Few fund companies are more focused than Royce & Associates. Although Royce runs a couple dozen funds (both open-end and closed-end), all of them specialize in identifying attractively valued smaller-company stocks. One of the firm's most compelling offerings is Royce Focus Trust (FUND). Run by Whitney George, this closed-end's assets have compounded by a sizzling 23% annualized over the past five years, an average of ten percentage points per year better than the Russell 2000 index.
George, who runs or co-leads a slew of funds, sees himself as a risk manager. Recently, when investors were shunning risk, he was putting cash to work. George runs a relatively concentrated portfolio of about 50 stocks, which he holds for an average of four years. A favorite current theme is steel, which has become a growth industry, mainly because of the global infrastructure boom. He's minted money by investing in unglamorous but lucrative scrap-metal processors, such as Schnitzer Steel. One large holding is Lincoln Electric, which makes welding equipment.
In energy, George likes some off-the-radar enterprises, such as Unit Corp., a Tulsa-based natural-gas drilling company, and Trican Well Service, of Canada. Wherever he buys, George says, he looks for strong balance sheets, high returns on capital and robust free cash flows.
Mixing stocks with stuff
We think commodities will remain an important investment theme for years to come. The demand for energy, metals and grains is insatiable in populous and fast-growing emerging markets, such as China and India.
DWS Global Commodities Stock (GCS) is an intriguing hybrid fund. Launched in September 2004, it invests in commodities through structured notes linked to the S&P GSCI index (typically 10% to 30% of the fund's assets are invested in direct commodities) and through commodity-related stocks (accounting for the remainder).
The flexibility allows manager Theresa Gusman to take advantage of disconnects in the market. For example, oil futures in mid May fetched about $126 a barrel, while prices of oil stocks seemed to be based on oil trading for only $70 to $80 a barrel. In this environment, Gusman would likely underweight the commodity and overweight oil stocks.
Gusman is currently playing two themes: China's explosive growth and rising demand for alternative energy. She owns stocks of companies that produce the natural resources that China lacks. For instance, in recent years China has become a massive net importer of iron ore, coking coal and aluminum. So she invested in those areas through stocks such as mining giants BHP Billiton and Rio Tinto. Her preferred vehicles for the growth in alternative energy are agriculture stocks, such as seed maker Monsanto and fertilizer producers.
Commodities may seem expensive, but Gusman believes rising costs and the imbalance of supply and demand underpin the high prices. Going back to 1870, she notes, major commodity bull markets lasted an average of 18 years. The current cycle is only six years old, she says, and there's never been a situation in which the likes of China, India, Russia, Brazil and the Middle East all passed through a commodity-intensive phase of economic development simultaneously.
BlackRock is a powerhouse in bond funds. As it turns out, it's no slouch in commodities, either, as evidenced by BlackRock Global Energy & Resources (BGR).
Co-managed by Denis Walsh and Daniel Neumann, BlackRock aims to generate high annual income by investing in high-yield securities, such as master limited partnerships, and by selling covered-call options on stocks as well as selling put options. The portfolio currently yields 4.3%.
BlackRock has also generated excellent capital appreciation by identifying attractive sectors and stocks, many driven by China's urbanization and industrialization. For example, Walsh notes that China exported 80 million tons of thermal coal three years ago but now exports little coal because it needs the stuff for domestic consumption. So he has loaded up on coal stocks, which have benefited from a 150% jump in the spot price of coal over the past year. This year, discerning a tight supply-demand balance for dry-bulk vessels, he invested aggressively in marine shipping. At last report, his fund had two-thirds of assets in domestic stocks and the rest in foreign issues.
The doyen of emerging-markets fund managers, Mark Mobius presides over a mighty empire at Franklin Templeton: $37 billion of assets and a team of 34 analysts and portfolio managers in 14 countries. It all started with the closed-end Templeton Emerging Markets (EMF), launched under Mobius in 1987.
Mobius thinks the closed-end format is particularly suited to volatile emerging-markets stocks. He doesn't have a problem with redemptions and funds pouring out when markets are down and stocks are cheap, or with the opposite situation of money flowing in when markets are frothy. "The best time to buy is when markets are down and the funds trade at a discount to NAV," he says. That situation prevails now.
Emerging markets, of course, have had quite a run this decade. But Mobius still likes what he sees. Developing countries should grow 7%, after inflation, this year, more than three times the rate of developed countries, such as the U.S. and Japan. Nations such as China, Russia and Taiwan are swimming in foreign-exchange reserves.
Mobius holds stocks for an average of three years. His fund is filled with large raw-material producers, such as Brazil's Vale do Rio Doce (the world's largest iron-ore exporter), Russia's Norilsk Nickel and Aluminum Corp. of China. "We think the shortages of commodities will continue for some time," says Mobius.
Mobius is also banking on rising consumer wealth in developing countries, a theme he plays through local banks, such as Brazil's Banco Bradesco, which is diversifying from commercial lending to consumer banking. "There's a whole new consumer revolution taking place," says Mobius.
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