Three CEFs Offering Assets on the Cheap

Call me cheap, but I love buying things at a discount. The idea of purchasing a dollar's worth of goods or assets for 90 cents makes my inner Buffet very happy.

One of the ways I think investors can benefit from "cheapness" is to purchase closed-end funds or CEFs. Closed-end funds are created during an IPO, with the cash raised invested. The shares of the fund are traded on the major exchanges just like regular stocks.

Unlike the current wave of Exchange Traded Funds, they are actively managed and do not represent a passive index investment. Managers have the ability to buy and sell as they chose. In addition, unlike a traditional Mutual fund, which share price is equal to its Net Asset Value, a closed-end funds price is a function of supply and demand. Therefore a fund can be trading at a sharp discount or premium to the underlying value of its holdings.

It is within this discount that we can find long-term bargains to fill our portfolios. CEFs come in a variety of flavors from emerging markets to highly leveraged junk bonds. Investors can find a fund to suit any investment need. I think a good place for investors to dabble in the world of CEFs is to take a look at a few of the Grandfather funds. These self-managed investment companies where created to do one thing: manage a pool of assets as a closed-end fund.

These stocks can serve as an addition to a core portfolio or as a main holding as they are filled with many blue chip and large cap stalwarts. Each was founded in the 1920s and has paid constant dividends for at least fifty years. These guys aren't for short term trading, but for "placing in a shoe-box and forgetting them for a while" style investment. Something you can purchase for the grandkids.

Tri-Continental (TY) was founded in 1925 by a junior clerk at J.W. Seligman. The original concept of the fund was to invest in companies on North and South America and those in Europe. Current holdings include Dow components Exxon-Mobil (XOM) and GE (GE) as well some growth holdings such as Marvell Technology Group (MRVL). The fund is leveraged through the issuance of preferred stock.

However, Tri-Continental is only leveraged a measly 1.56%, very small by closed-end fund standards. The fund has paid dividends constantly for 63 years and its current policy is to distribute quarterly 2.75% of the fund's net asset value. This equates to an impressive 11% yield on NAV or 12.60% on share price. Tri-Continental is currently trading at a 10.31% discount to its 2.2 billion in holdings.

The Adams Express Corporation (ADX) was founded in 1840 as a courier service specializing in the transport of securities and other related documents. By the end of the 1920s Adams become more of a holding company for various investments and converted into an investment manager and closed-end fund in 1929. The company has paid dividends ever year for 73 years and only paused for a brief time during the Great Depression.

In keeping with the long term nature of the fund, managers Joseph Truta and Douglas Ober have been at the helm for over 22 years. The internally manage structure keeps expenses low at 0.44% and the fund has returned 12.45% since inception based off share price. The 13.86% discount allows shareholders to purchase such companies Conoco-Phillips (COP), Sclumberger (SLB), PepsiCo (PEP), and Microsoft (MSFT) at closeout prices.

General American Investors' (GAM) primary objective is long term capital appreciation and growth and the fund has done just that, receiving numerous awards from Lipper. General has outperformed the other core closed-end funds, for ten year periods ending each year from 2003 till 2007. Earning in the process, an annual return based off share price of 15.77%, since its inception in 1927. The fund is leveraged via a preferred stock offering in 1998.

General American may offer the diverse group of holdings including Halliburton (HAL), Nintendo (NTDOY.PK) and Costco Wholesale (COST). The fund is currently trading at 9.78% discount to its NAV. Volume for GAM can be a little light as there are only 31 million shares available. Limit orders would be advised for purchase. The fund also pays dividends twice a year; however the amounts vary widely, with most of the bang coming from long term capital gains.

Most Investors over look closed-end funds for their portfolios, which is a real shame. Those of us with long term focus can really find some dollar store bargains if we take a look at the net asset values of the funds. The preceding funds offer investors a chance to try their hands at the world of CEFs while getting some quality holdings on the cheap. I would urge anybody with a long term focus to give GAM, TY and ADX some further due diligence in order to make a nice addition to their core portfolio.

Disclosure: None

Comments

[Jonathan Liss, SA Editor]

Nice piece.

However, the risk with CEFs trading at a discount to NAV is apparent if you look at CAF's trading over the last 6 months or so: www.etfconnect.com/sel...

The China A-shares CEF spent many months trading at a discount of over 20%, topping 30% at a point. However, that gap has now closed to approximately 5% as Chinese markets have sold off. Needless to say anyone holding the fund through that time has not done well, and the discount is now no longer impressive enough to warrant holding it.

This of course may not be relevant to the CEFs you mention as they may not be 'market-specific' enough, as CAF is, to warrant such a precipitous sell-off and narrowing of their respective discounts.

[billb]

The commentor above makes the same point I wanted to make. Stocks can be "cheap" relative to book value as well, but there is typically a reason for it. I'm not a pure momentum guy or a pure value guy, but when things are cheap, you have to ask yourself why. I wouldn't just look for the cheapest CEF and have at it. Another thing that turns me off from CEFs are the spreads and liquidity issues they typically have.

[Sapwraia]

I would challenge the long term attributes of these CEF's - just chart them against the S&P 500 this decade.

For a good benchmark of a globally diversified large cap CEF that really performs just look at ticker RCP on the London exchange - it's the Rothschild Investment Trust and is a security which can comfortably be one's largest holding (it actually carries a premium - for good reason ! )

[Neil Harkins]

In answer to Jonathan, above: Buying and holding stocks or funds concentrated in any volatile market merely allows you to watch the ups and downs of the issues, as they bob on the surface of a tempestuous sea. I have actively traded CAF since May, 2007, experiencing more than a 100 percent profit by selling and buying it back a few times; you have to play the volatility of issues such as CAF in order to make substantial gains. On the other hand, just allowing LDF (Latin America Discovery Fund) to "cook" without trading during the same time period, has returned more than 50% in its appreciation, and in the enormous dividends it has paid.

But, you must ask yourself, "What is the true value of a stock or fund, or anything else, for that matter?"; it may have some verifiable intrinsic financial basis, that the majority of people may never know, but you can be sure that the "price" is what we all get to pay, and oftentimes the "price" (governed very often by hype and other questionable influences) has very little to do with the "value". Not to sound overly metaphysical, but we value and price assets (intrinsic and otherwise) in the United States in U.S. Dollars, but what is a U.S. Dollar worth? We don't know that, so how can we be expected to know the "value" of things denominated in it? I wager that the "value" of a piece of bread and a glass of water in the middle of the desert, after you have been forced to "fast" for a week, is worth all the gold bars you have in your backpack; back at the oasis, the price is far less.

The bottom line: It really does not matter much whether a Closed-End Fund is trading at a discount or a premium to its Net Asset Value, because it is all a matter of what you and others are willing to pay for the shares, and that attitude can turn on a dime (see MXE between July and September, 2007); the fund's price in relation to the prices of the fund's underlying stocks is just a talking point, but also throws a little mystery into the equation... your profit or loss will still be governed by the difference between what you paid and what you received when you liquidated. You have to pay attention to the Market sentiment for whatever issue you own, and attempt to trade it in whatever range it currently fluctuates. Of course, if the CEF was trading at a nice discount, and the fund was suddenly "Open-Ended" by management, then the price of the shares would instantly equal the price of the NAV, and that might give you cause for celebration, even with a Dollar in as deplorable state as it is today.

[OJO Zafado]

I strongly disagree with Neil's valuation argument. I have done best in the CEFs that sold at a decent or even compelling discounts. GLQ,WIA, and CEE have all been winners. The IFN is really getting beaten down and seems like a nice play on the BRICs, eventually resuming the lead in growth in the world economy. The other key is as the author alluded to is the amount of leverage these funds typically carry in terms of short term auction rate preferred securities. This has been a disaster for so many of the CEFs. The AOD comes to mind as a fund that does value/dividend investing with out the leverage. The author seems to have found the funds that have limited exposure to the worst performing sectors in the market. The beaten down valuations and discounts to NAV may be because they have sold such investments and moved on. We are left with the beaten down asset now devoid of the usual suspects that may have brought the CEF to these valuation levels. One mans trash sometimes becomes another's treasure. Neil's observation about CEFs converting to ETFs is a good one. If you can't beat 'em join 'em is the philosophy sometimes. Especially if a CEF is in a suddenly "hot" sector converting to an ETF may actually increase management's net fees by virtue of dramatic fund inflows.

[Roudy]

Your information is once again very interesting. I thoroughly enjoy reading about the different ways of investing. Keep up the good work.
RoudMan

[carls]

Regarding TY - be careful. They have an "optional" dividend that requires a response from you or else it's re-invested. An awful mess when you go to sell.

Because it's labeled "optional" many brokerages can't handle it under the "do not reinvest" instructions. Make sure before you buy.

[Bruman]

I've always been a little foggy on what factors drive the discount or premium on CEFs. Yeah, sure, there's supply and demand, which is basically about popularity, which is more or less unpredictable. But what else?

[deerfool]

What are the best references, websites, etc. available regarded closed end funds?

[grunt0311rvn]

Looking for low risk CEFs.