The Only Fund That Ever Goes “On Sale”

Americans are comfortable with mutual funds. According to the Investment Company Institute, we have over $15.6 trillion invested in them.

But there is another type of fund, one that holds much less in total assets but that is often a better bargain. They’re called closed-end funds. And if you aren’t familiar with them, you should be.

[ad#Google Adsense 336×280-IA]Open-end funds, like those offered by Fidelity, Vanguard and other leading mutual fund groups, continuously offer and redeem shares based on each day’s closing net asset value.

Closed-end funds are different.

They raise money on an initial public offering, just like a company going public, and then begin trading on an exchange.

Because these funds trade like stocks, you buy them in a brokerage account and can trade them intraday using market orders, limit orders or stop orders.

They are marginable like stocks, too.

A closed-end fund’s market price at any given time may be higher or lower than its net asset value. If it is trading above the net asset value, it is said to trade at a premium. If it is trading below the net asset value, it is trading at a discount.

Few buy or sell signals are more obvious than buying these assets at a discount and selling them when they reach a premium. If you do this successfully, you’ll benefit from not only the fund’s rising net asset value, but also the shrinking discount.

In essence, you have two ways to profit here instead of one. Perhaps that’s why closed-end funds are growing in popularity.

In 2002, for example, U.S. closed-end funds held only $156.4 billion in assets.

Today, these funds – while much fewer in number due to mergers and liquidations – hold over $261 billion.

Closed-end funds often pay substantial dividends. In 2015, they distributed $16.8 billion to shareholders. That includes income from interest and dividends, realized capital gains and (sometimes) return of capital.

Of course, assets in closed-end funds also greatly trail another type of publicly traded fund – ETFs, or exchange-traded funds. Unlike closed-end funds, ETFs are usually unmanaged – although that’s changing too – and have an arbitrage mechanism that keeps them from trading at a significant discount to net asset value.

It’s the discounts that create the bargains, especially for investors seeking high monthly income.

Take the Aberdeen Asia-Pacific Income Fund (NYSE: FAX), for example, a fund that invests primarily (61.7%) in Asian bonds. (Roughly half of them are A-rated or better.) Based on its currently monthly distribution of $0.035 a share, the fund yields 8.6%. One reason that’s so high – aside from the fact that it invests in some non-U.S. bonds with greater yields – is the fund currently trades at an 11% discount to its net asset value.

An investor here is buying $1 worth of assets for $0.89 – and getting a higher-than-average yield as a result.

Now let’s take an opposite example. According to The Wall Street Journal’s data center, PIMCO Strategic Income Fund (NYSE: RCS) is trading a whopping 19% premium to its net asset value.

This not only isn’t a good buy, it’s a very dangerous hold, as the fund could easily trade back to (or below) its current net asset value of $7.61.

Why is the fund trading at such a huge premium? No doubt existing shareholders like the current yield of 10.1%. But the fund is using leverage to earn this return. Combine the risk of a leveraged portfolio with the risk of holding a fund trading at an enormous premium, and it’s clear that these shareholders are essentially asleep at the wheel.

These two examples are closed-end funds using very different strategies. But even a cursory glance tells you that the Aberdeen fund may be a bargain.

The PIMCO fund? It’s just an accident waiting to happen.

Good investing,



Source: Investment U