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Closed End Funds - Advice?
Old 12-21-2007, 11:23 AM   #1
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Closed End Funds - Advice?

WSJ had an article today "Year End Bargains on Closed End Funds" that pointed out some unusually large discounts on closed end funds due to year end tax loss selling. Many of the funds they cited have discounts near 15% and dividend yields above 10%. That sounds pretty attractive to me for some cash I have sitting around from selling some losers among my high dividend stocks.

Do any of you have experience (good or bad) with closed end funds? Any land mines I should watch out for? Do I need to be concerned about "buying a dividend" near year end like with mutual funds? The specific funds cited in the article were: FFA, PJG, JPZ, ETJ, FOF, CSQ, CII, BGY, EXG, EDD and GLO. Any comments on any of these as income investments? Thanks.

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Old 12-21-2007, 11:48 AM   #2
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I will refrain from commenting on the specific funds you list. However, every so often CEFs become an enormously good deal. What you want to watch out for is:

- Leverage: the funds with the highest yields and biggest discounts often employ leverage. This is a much bumpier ride than an unleveraged fund, and current issues with liquidity in the market make this especially dicey. Try to stick to unlevered funds.
- Expenses: It is not uncommon for leveraged funds to have expense ratios north of 1%, and I have seen north of 4%.
- Iffy assets: Wanna own Venezuelan sovereign bonds on a leveraged basis? Me neither. Look past the discount and dividend and make sure you are comfy with the assets in the fund.
- Discount history: If it has always traded at a 10% discount, a fund trading at a 12% discount isn't that interesting. If it trades at 3 to 5% discount normally and is now at 15%, its a lot more interesting.
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Old 12-21-2007, 12:16 PM   #3
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Of those, the only one I've poked at before is JPZ. They use an options strategy to reduce volatility (selling naked puts and covered calls). Reputable management, relatively low fee. I bought some today -- thanks.
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Old 12-21-2007, 03:28 PM   #4
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Many high CEF payouts are not supportable, they are a return of capital. Anything with a 10% return probably falls in that category.

The CEF I own, ETG, uses leverage but other than that it has a conservative reputation. It uses the Dividend Capture strategy to harvest a couple extra payouts each year. There are several other strategies but most don't seem sustainable or are untested during a downturn.

The cefa.com and etfconnect.com sites have some screening tools that allow you to sort CEFs on various factors, discount being one of them. I'll usually screen for equity funds selling at a discount, sort the list by discount, and spend some time looking at each fund.

If the fund seems to have a decent record I'll look further. I like to see that the NAV and dividend payout has grown over time. I'm not interested in anything exotic, but global exposure has been a plus over the last five years, though that will probably change before too long. If the fund focus is narrow, like exclusively energy and basic materials, I'll pass.

There are a couple good CEF forums you might want to visit.

Closed-End Funds

RETIRE_with_CLOSED_END_FUNDS : RETIRE with CLOSED END FUNDS
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I think WSJ is right some good deals
Old 12-23-2007, 05:39 PM   #5
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I think WSJ is right some good deals

I've bought and sold some closed end funds (CEF) in the past but never really studied them closely until the last couple of days. Now 2 days of research doesn't make me an expert, so I'd appreciate any corrections to my little primary about CEFs. I found them potentially very interesting investment primarily because discounts on certain types of CEFs have widen considerably and reached multi year highs.

How Equity CEFs work.
From what I can tell, a company like Nueeven (the old name in CEFs) or Eaton-Vance, decide to start a new CEF. The come up with a theme and cool name like Enhanced Global Equity Income Opportunities and get their team of brokers and distributors to raise ~$1 billion by selling ~50 million shares at $20/share. The marketing pitch for equity CEFs is they pay a steady (or rarely increasing) income that is higher than you'd get with CDs or bonds. Generally they pay between $.10 to $.15 per month/share, which works out to be between 6-9% on the initial $20.
After paying front end loads and costs typically the funds end up with around $19/share in assets.

Now as we all know finding stocks that yield 6% isn't easy much less 9%, so pretty much all of these CEF employ a gimmick strategy. One typical strategy is to use leverage by issuing preferred shares and using the borrowed money to juice up the returns.

Another strategy is to write covered calls either on individual issues or indexes like the S&P, NASDAQ, or international index like the FTSE. They use the option premium to make the monthly income payments. Finally, they all encourage dividend re-investments which provide another source of funds to pay current stockholders.

Now in rising market this all works out hunky dory. There is enough cash flow from dividends, option premium, dividend reinvestment along with taking some profits to make the monthly payments. In addition, the NAV raises slightly and the market price tracks the NAV (in some case they even sell for a modest 3-5% premium!). Susie and Joe investor receive their 8% income each month and everybody is happy, especially the issuers who collect their ~1% (or higher) expense ratio or $10 million on $1 billion fund.
Joe and Susie don't real care the funds trailed the S&P, Russell 3000, or EAFE.

In a bear or even a volatile market the situation changes, for funds with a high distribution level, there isn't enough income, and capital gains to harvest to pay out the monthly check. So rather than cut distributions, the funds return some of the paid in capital. This reduce the amount of assets available to generate income, which in turn makes next quarters distribution tougher to meet. Susie sees that price of her funds drop and for whatever reason decides to sell, since she can't redeem shares she has to find another investor. Since the market for funds that lose value is pretty small, the gap between the NAV and market price widens. This doesn't cause the fund manager much lost sleep cause they still collect their paycheck based on NAV, not market price or shareholder return.

CEFs Today
Still what has happen this summer has been pretty remarkable. Early in the year most of these Equity CEF (JPZ, JSN, EOI, ETB,ETW etc.) that used covered calls were trading near there NAV in some cases even a bit above, but since the summer the discount has widen to 13-15%. The NAV of these funds has barely changed typically remaining at about $19 +/- $1 for the last couple of years. Meanwhile the funds are distributing about .40 to .45 a quarter (8-9%) in income, cap gains (and some return of capital.). I (and evidently the fund operators) are puzzled why mildly bullish strategy like writing covered calls (which should benefit from increased volatility) is being punished.

The discount has widen for most other CEF, including some like AzDreamer own, ETG, that actually have increased distributions, but not as much as covered calls CEFs. Finally I did come across one speculative fund that I think shows the market is crazy. RMT Royce MicroCap Trust as the name implies invest in companies with less than $500 mil market capitalization. Run by fund family founder, it 14 year old fund with CAGR of 13.5% since inception or a 5 bagger. On 12/31 2006 the NAV was $14.77 and the share price was $16.57 a 12% premium. This year the NAV is 13.57 but when you add back the $1.35 distribution the fund actual made money. However, Mr. Market thinks the fund is only worth $11.80 a 13% discount so a 25% swing in one year on virtually the same pool of assets.

Now, I am not completely sold on CEF since I don't like paying a high ER for mediocre performance, but I do like being able to buy $1 worth of stocks for $.85
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Old 12-23-2007, 05:49 PM   #6
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I think you covered it pretty well. *Never* buy a CEF when it's first issued. These things are all about the front-end load. But once they start trading at a heavy discount on the secondary market, toss out the ones with high fees, and go shopping.

They make a lot of sense for income because then you don't worry so much about what the discount might be when you sell. Although some people buy these things as a bet on a narrowing discount.

I don't even mind return of capital when it's somebody else's capital being returned to me.
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Old 12-23-2007, 07:03 PM   #7
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I don't even mind return of capital when it's somebody else's capital being returned to me.
Exactly. If you put $1000 in a fund at a 15% discount, and they immediately give you a $100 return of capital, you have a $15 profit right then, since you only paid $85 for the $100 they are returning to you. So 15/85=>17% for something requiring little thought.

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Old 12-24-2007, 03:13 AM   #8
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problem is because market sentiment is involved that discount may always be present and even grow larger over time. its rare to find cef's that trade at their exact value. the hot ones always seem to stay at a premium and the out of favor at a discount.
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Old 12-24-2007, 04:32 AM   #9
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problem is because market sentiment is involved that discount may always be present and even grow larger over time. its rare to find cef's that trade at their exact value. the hot ones always seem to stay at a premium and the out of favor at a discount.
Yes that is what scares me about this things although at some level if they are returning 10-12%+ a year maybe I don't care about the selling the fund no matter what the discount is..

I did notice that when the discounts get really large >-12% that Fund families will announce share buy backs. (Now of course announcing buybacks is easy actually doing it is a different story.)

One question I have for any Closed Fund experts. Let say I had a couple billion hanging around. Would it be possible for me to buy large interest in the shares of a CEF selling for a discount, propose and pass a resolution disbanding the fund. Basically fire the manager andsell the assets and distribute the discount to the shareholders?
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Old 12-24-2007, 05:13 AM   #10
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good question, shooting from the hip it makes sense but i dont know enough about the structure. there may be other things involved below the surface that prevent you from recapturing that discount just like in etf's they are structured and paid for by the issuers in such a way that prevents them from trading at a discount or premium. the issuers must pay for them by buying the actual assets in them. its very complex but it keeps them very close to nav,

found this blurb on the internet

A closed-end mutual fund is much like an ETF—it sells shares representing a basket of securities on a stock exchange, and trades just like a stock, but, because it has no legal provision for exchanging the shares of the fund for the securities after the fund is created, the share price of the fund frequently deviates by a large amount from the NAV of the fund.
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Old 12-24-2007, 08:59 AM   #11
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One question I have for any Closed Fund experts. Let say I had a couple billion hanging around. Would it be possible for me to buy large interest in the shares of a CEF selling for a discount, propose and pass a resolution disbanding the fund. Basically fire the manager andsell the assets and distribute the discount to the shareholders?
Depends on the CEF, but I watched one of my favorite regional insurers do exactly this a couple of times before the fund manager started to take very aggressive counter-actions.
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Old 12-24-2007, 09:20 AM   #12
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A few over the years have been open-ended, usually from outside but occasionally by fund management itself.

I have sometimes bought CEFs; one problem is that some managers-Gabelli jumps into mind- are pretty good at coercing more money out of you as they do rights offerings or sometimes follow-ons and you pay to play or get diluted. From the POV of a manager, a CEF is a very good thing as the money can't go home no matter how bad the performance.

It works the other way too. If the manager is very successful, it can usually grow an open ended fund more cheaply and easily than a CEF. The fund that is managed by Marty Whitman and called Third Avenue Fund started life as Equity Strategies Fund, a small CEF. At the time M.J. Whitman and Co, owned the fund, and put in a really excellent performance. After a few years there was one highly appreciated stock, Nabors Industries. It had come out of a preplanned bankruptcy reorganization of the stub of the old Guggenheim copper interests in South America.

Anyway, Whitman figured out a tax efficient way to get those shares to the Equity Strategy Shareholders, and also started TAVF. I was small shareholder in Equity Strategy- I think it was EQS. And of course TAVF has been very successful and has grown to be quite large. Whitman also opened several other successful value funds, and a few years ago cashed out by selling to ? American? Or some other large fund marketer. His crew still manages the funds with the Third Avenue name.

It was such a creative tax minimizing solution and fair treatment of shareholders that TAVF has remained one of only 2 mutual funds that I own.

Ha
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Old 12-24-2007, 03:18 PM   #13
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The only one I am following now is SOR. Finally starting to trade at a discount. I have a lot of respect for the firm that manages that particular CEF.
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Old 12-24-2007, 06:10 PM   #14
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Exactly. If you put $1000 in a fund at a 15% discount, and they immediately give you a $100 return of capital, you have a $15 profit right then, since you only paid $85 for the $100 they are returning to you. So 15/85=>17% for something requiring little thought.

Ha

Ha,

Good point. But now your $1,000 investment is only worth $900.00. As the ROC is deducted from the market price. I'm probably missing something. Please help.

Thanks,
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Old 12-24-2007, 06:45 PM   #15
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EQS is one of the most unusual CEF I've looked at it trades at amazing 40% discount to NAV and it appear to much more a business development company than traditional close end fund. The 40% discount caught my eye, but after looking at it, it appeared to fall in the too hard to understand category.

Ha Ha is EQS something you'd recommend, and if so could you share a little information about it.

SOR is CEF that didn't hit my radar screen before. However a 5 star rating from M* a 40 year track record, with more than respectable 12% 10 year year CAGR, coupled with a modest .9% ER make it worth watching. Interestingly enough after trading at double digit premium for most of 2000-2006 it too has slipped into a discount. Although the discount is fairly narrow 7%.
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Old 12-24-2007, 07:18 PM   #16
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EQS is one of the most unusual CEF I've looked at it trades at amazing 40% discount to NAV and it appear to much more a business development company than traditional close end fund. The 40% discount caught my eye, but after looking at it, it appeared to fall in the too hard to understand category.

Ha Ha is EQS something you'd recommend, and if so could you share a little information about it.

SOR is CEF that didn't hit my radar screen before. However a 5 star rating from M* a 40 year track record, with more than respectable 12% 10 year year CAGR, coupled with a modest .9% ER make it worth watching. Interestingly enough after trading at double digit premium for most of 2000-2006 it too has slipped into a discount. Although the discount is fairly narrow 7%.
clifp:

Stay tuned on this one. I don't own it now but will if it dips to the double digit discount range. I think a CEF structure is more beneficial to their style. Their open-end funds charge apprx 1.35 or so a pop so you get a pretty good deal for a lot of the same ideas - most of their funds have common holdings and they work closely together.
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Old 01-07-2008, 06:27 AM   #17
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Ok a bit of bragging.

After being alerted to Grumpy on the Closed End Xmas sale, I did some research which I posted about and then proceeded to buy 6 CEF right around XMAS. (The reason I bought so many funds was because the trading volume is fairly light and even relatively modest 1000 share purchase @$15-$18 were hard to execute with a reasonable spread).

The discount to NAV ranged from 8.5% for SOR to over 14% for some like JPZ and RMT.
Here is what I have found remarkable in less than two week the discount to NAV has narrowed by an average of 6%. For instance SOR is now trading at less than 2% discount, which means despite the horrendous start for the market this year. I am actually making a modest profit on 5 of the 6.

Now with expense ratios of around .7 -1% most of these aren't funds I am interested in owning forever but I do think that its worth looking when the discounts to NAV start getting into the 11-15% range.

I also have a partial theory to explain what happens. Many of the closed end funds make a regular quarterly distribution and also a cap gains distribution in the 4th quarter.
Typically the go ex dividend Nov 30, but the pay date isn't tell the end of the year.
I suspect that naive investor or even careless brokers saw the NAVs drop at the end of Nov and just went crazy tax harvesting.

Unfortunately looking at the discount ratio for equity CEFs I don't like any of them that are currently exceed 10% since they for the most part have 1-2% expense ratios and generally unimpressive and/or short track records. One exception maybe the China Fund CHN which is trading at an 18% to NAV, but that is different animal than buying a CEF with US and/or developed country stocks.

Still I think it worth keeping a look at for widening discounts in the future especially near the end of the year.
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Old 09-21-2008, 01:54 AM   #18
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[resurrecting an old thread]
How has your strategy of buying CEFs with deep NAV discounts held up over CY2008? Any pearls of wisdom to share?
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Old 09-21-2008, 02:07 AM   #19
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[resurrecting an old thread]
How has your strategy of buying CEFs with deep NAV discounts held up over CY2008? Any pearls of wisdom to share?
In very stressed times like earlier this week, you can get amazing bargains. I bought one, ADX, for a long term holding with a very low expense ratio and a 17% discount. This essentially means that they are paying me to manage my money, not me paying them. It also enhances dividend payout.

But for short term plays there were even more amazing deals. Like DCS, which I was into and out of in 2 days. It may still be a good holding, but I don't really care. For me it was a pure discount play.

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Old 09-21-2008, 09:12 AM   #20
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Slouch thanks for resurrecting the old thread. I was just thinking about posting again on the subject.

The update on last Dec. action. I sold all but two of the funds RMT (A microcap fund which is going to be a long term buy and hold for me, and JPZ because the discount never narrowed. I made a modest profit on the other 5 no easy feat in the last year. Again not so much cause the funds did well (although several were involved with writing covered calls which reduced loss this last year) but just because the discount narrowed.

Just Friday I started buying back into more CEFs. During the last two weeks discounts on many CEF equity funds have increased to 20%+ On Friday some of the discounts narrowed a bit but as Ha Ha said some of the discounts were remarkable.

To use DCS as an example it was up 18% on Friday but it is still trading at 26% discount to fair value. Ha Ha I sure made a pretty penny on it.

It is important to note that news surrounding closed end funds is incrediably bad. First the auction rate security market which CEF use extensively is in shambles. Next the overall credit market is just as bad making borrowing (many of these funds are on leverage) more expensive. Because they are often income focused they own financial common and prefered shares (DCS had in its top 10 holdings Fannie Mae prefered and WaMu) Many of the CEF ae owned in part by investment banks, which have obvious problems. Finally for the most part initial offering of CEF are sold by brokers to retirees looking for income. Not to put to fine a point on it but you have to be a financial idiot to buy a CEF from a broker instead of waiting to buy it on the secondary market without any commission. I am reasonably sure that a good chunk of these people panic as they watched the value of these things plummet and instructed the broker to SELL SELL SELL.

Ha Ha I am curious about ADX, long track record low expense but what makes it special?
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