Monday, July 18, 2005
Closing in on Closed-Ends
CLOSED-END FUNDS HAVE FEW FRIENDS. Oh, sure, brokers like them, especially when they get to flog new issues with the pitch that there’s no commission. But they may not tell you that you’re paying a buck for perhaps 92 cents’ worth of underlying assets. And that, after the fund starts trading in the aftermarket, its share price could well head to that net asset value—or lower.
At that point, the critics of closed-ends can carp about what a lousy investment they are. And, to be sure, many are. Some have high expense ratios—higher, in fact, than the 1%-plus that their open-end mutual-fund counterparts levy. And if you don’t buy them during their initial offering (when you’re paying the underwriters, whether you know it or not), you must pay brokerage commissions, as you would with a stock. With many fine no-load and low-cost mutual funds available, plus an ever-expanding array of exchange-traded funds, who needs closed-ends?
Well, sometimes, there are excellent reasons to buy them. The funds sometimes trade at prices below the value of their underlying holdings. Thus, it’s possible to pay 90 cents or less for a dollar’s worth of assets. That’s always been the attraction of closed-ends, and shopping for funds at a discount is one of the oldest investment tacks. And now, various Websites provide ready access to information that used to take a lot of digging, while low-cost online brokers minimize transaction costs.
Closed-end funds issue a set number of shares and trade like stocks and exchange-traded funds. Closed-ends, however, can and do change hands at prices above or below their net asset value. ETFs, in contrast, rarely stray from their NAVs, and open-end mutual funds continually issue and redeem shares at their net asset value. Closed-ends are actively managed, often by the same firms that offer open-end funds, while ETFs are based on some broad market index or a certain sector.
One advantage that closed-end fund managers have over their open-end counterparts is that they don’t have to worry about shareholder redemptions when the market goes south. That makes them more suitable for relatively illiquid asset classes, such as foreign securities. How can you seek out these attractive closed-end funds? One way is to go through Barron’s lists of the funds with a highlighter pen, and take a closer look at those trading at a deep discount. Then there’s the Web. You’d think that the best sites to research closed-end funds would be the same as those for open-ends. But Morningstar (http://www.morningstar.com) no longer does active research on individual closed-ends, although its premium site offers screens based on asset class, returns, premiums or discounts. Just don’t expect detailed writeups like those the firm provides for open-ends.
The Closed-End Fund Association, a trade group, offers the Closed-End Fund Forum. You’ll find its Website at http://www.closedendfundforum.com; it’s worth a look. Forget the dated news and research, but check out the array of useful statistics, which appear on the right side of the home page. Scroll down to find Fund Statistics in the right-hand column. Click on Premium/Discount and, when the table comes up, click the Sort by Premium/Discount heading. Scroll to the bottom of the list to find the most deeply discounted funds. Other handy listings include daily winners and losers, which may present opportunities in this often-inefficient market.
The same trade group runs http://www.closed-endfunds.com, which offers timely press releases from funds and weekly roundups of fund performance, including the biggest winners and losers. The site’s listing of recent initial public offerings is especially useful. That’s not to suggest you chase hot IPOs; in most cases, quite the opposite. Once the underwriting of a new fund ends, it typically falls from its offering price. It’s like buying a car right after it leaves the showroom. Its price is markedly cheaper, even though it’s just as good as new. The losers’ list, meanwhile, might point to some ideas for bargain hunting, but you’ll want to do some research before buying.
Our favorite site for closed-ends is ETFConnect (http://www.etfconnect.com). Notwithstanding its name, it offers extensive current information on closed-ends, as well as on ETFs. The site is run by Nuveen Investments, a leading issuer of closed-end municipal-bond funds, but it plays no favorites.
Look under Closed-End ETFs in the left-hand column, which lets you sort closed-ends based on such criteria as size of discount. ETFConnect has another feature that is a great help to closed-end investors—the Multi-Fund Review, which lets you check out funds by sector.
You can click on an individual fund to see the basic data, including NAV, most recent closing price, biggest holdings and recent dividends. It will also show how much leverage, if any, the fund is using. Leverage can improve a fund’s returns but increase its risk.
There’s also a neat little chart showing the trend in the fund’s discounts. Some have remained at discounts forever, so they might not be a bargain, even at 90 cents or less on the dollar. On the other hand, the fund might suddenly have fallen out of bed for a good reason—say, a dividend cut. By then, the bad news may already be fully discounted in the closed-end’s market price.
ETFConnect also provides links to a particular fund’s own Website, which often is the best source of information. While some funds’ sites may only show marketing materials and recent reports, most of the better ones list the details of the portfolio. ETFConnect can help illuminate a fund’s expenses. A closed-end fund has little incentive to minimize expenses, as might an open-end fund looking to market more shares. Indeed, outrageous expenses may account for a closed-end fund’s discount, in which case a discount may represent no bargain at all.
One other thing to watch with muni closed-ends: the percentage of bonds subject to the alternative-minimum tax, an increasingly important consideration as more investors get snagged by this insidious levy.
Closed-ends also can be researched like stocks, using the tools of your online broker or sites such as Yahoo! Finance (finance.yahoo.com).
One thing to look for is insider buying. Most of the time, it will take the form of small purchases by fund directors. But sometimes, you can pick up more significant trends. For instance, the CEO of a fund complex might be scooping up a closed-end that had dropped to a discount. Last year, Nuveen Investments’ chief executive, Timothy R. Schwertfeger, bought some 35,000 shares of Nuveen Tax-Advantaged Total Strategy Return Fund (ticker: JTA) at about $17 to $18 a share—below the $20 price Nuveen charged the public in the fund’s IPO on Jan. 27, 2004. The fund since has climbed back to within pennies of the initial offering price.
There are also a few firms specializing in closed-end investing. One is Thomas J. Herzfeld Advisors (http://www.herzfeld.com) of Miami, which provides the index at the start of Barron’s closed-end listings each week.
Most of these Websites are free of charge, and include educational content about how closed-end funds are formed and managed. More importantly, they provide a wealth of information for investors looking to take advantage of this often mispriced and misunderstood sector.
Published in Barron’s July 18, 2005