When it comes to electronic gadgets and the latest fashions, deep discounts usually entice shoppers to buy. Not so with investing. Oftentimes, the greater the discount, the more buyers stay away.
Nowhere is this assertion more evident than in closed-end funds, a quirky corner of the mutual fund universe now sporting some of the biggest bargains seen in a long time. Closed-end funds are now trading at an average 6.3% discount to their net asset value. “This definitely creates an opportunity,” says Gregory Anderson, whose Denver-based firm, GRAnderson Wealth Management Group, manages nearly $10 million in client accounts.
Unlike their more common open-end cousins, closed-end funds trade with a fixed number of shares. The share prices do not always reflect the value of the funds’ underlying investments, however. For that reason, closed-end funds can trade at discounts or, less likely, premiums to their net asset value. Why these pricing disparities exist is the subject of great debate among the small community of analysts who follow the funds. Regardless, discounts can often present a chance to buy solid investments cheaply.
Discounts aren’t an automatic reason to invest. Sometimes they’re warranted. For example, some closed-end funds that invest in Chinese stocks had a superb performance in early 2007, but developed discounts by year’s end on investor fears that the stocks are due for a tumble.
“You don’t have to be Warren Buffett to figure out that a closed-end fund is undervalued,” says F. Barry Nelson, lead portfolio manager of the Advent Claymore _Convertible Securities & Income fund, which is trading at a nearly 10% discount. The fund’s manager is New York-based Advent Capital Management (No. 4 on the be asset managers list with $3.1 billion in assets under management). “You can see what its value is and you’re able to buy those securities for 10% less than what they’re worth.”
With few analysts covering them, closed-end funds can seem under-hyped. But note that a good number of closed-end funds offer sizable dividends. The discounts make these even more attractive. The more prices fall-and therefore the more discounts widen-the higher the yields become, similar to how bonds trade.
Even with the potential for gains, investors should exercise caution. First, buy a fund whose objective meets your investing needs, not necessarily one with a deep discount, cautions Tom Roseen, senior research analyst with fund tracker Lipper. Also, steer clear of closed-end fund IPOs because prices almost always fall in the following weeks. And finally, purchasing a fund at a premium hardly ever pays off.