Originally Posted by wab
I have to wonder if the market is smart enough to pick the "right" discount.
There's supposedly a lot of dumb money: people who are sold these things, and then sit on them, and either never vote or blindly vote with management.
As evidence, you can look at how people actually vote against their own interest.
Then there's the multitude of small players like those on this board or http://finance.groups.yahoo.com/group/closedendfunds2/
, of varying sophistication, and with different strategies, who try to profit from the discount in a few different ways.
Higher up the chain is the institutional money, places like Harvard, Lazard, Bank Berlin, Opportunity Partners, City of London, etc, with tons of money to throw around. (Well, OP may not be that huge)
These institutions should have the resources to get valuations right. Not sure of this, but I suspect they most often invest in funds they hope can be forced to open end or liquidate, or at least can be pushed into shrinking the size of the fund to narrow the discount. Which leads to the top of the food chain:
Entrenched management. Shareholders like Harvard are usually no match for the de facto owners of the cefs, the management. They will often use every trick in the book, and use shareholders' own money, to fight off those pesky shareholders and maintain their lucrative position.
Sometimes the discount is an expression of the probability of survival of management.
For funds which have little institutional ownership and little chance of open ending, perhaps the price is more likely to diverge from the "correct" price?
Two more comments:
-Rights offerings cost real money. The investment banks take a significant cut off the top, and this is an ongoing cost of owning many cefs, on top of the hidden costs of trading and explicit costs of ER, one should account for. In some cases, you can reduce this cost (or even profit) by oversubscribing, but not always IIRC. (Would depend on how much you can oversubscribe and at how much discount, compared to how much dillution caused by the investment bank's cut. And you won't know ahead of time.)
-The movement of the discount can be a big source of profit or loss. I wouldn't count on big profit from it from today's meager discounts, but in the past it has been very good to me, sometimes when the market hasn't!
Of course if the discount increases by 15%, you can just stay put and happily pocket the dividends, if you bought in cheap enough so the yield was decent even after ER and rights offerings, based on initial discount.
(I haven't been following Adams Express)