- The Washington Times - Monday, November 17, 2008

Bullish investors like to spin the current market problems as saying that the downturn has put great names “on sale.”

In a typical retail sale, however, consumers know just what they are getting because they can see that the sale takes, say, 25 percent off the ticket price. With investments, however, the typical investor is guessing at how big a bargain he is getting.

The one exception is closed-end funds, in which investors looking for both bargains and income streams get a price tag that shows the size of their current discount. With that in mind, closed-end funds are an intriguing choice for current market conditions.

“When people see that they actually calculate the discount on a closed-end fund, I think they believe this must be the scratch and dent sale on portfolios, that something has to be wrong,” says Jeff Tjornehoj, senior research analyst at Lipper. “Nothing could be further from the truth. Many closed-end funds resemble the funds you might hold in your 401(k), but you know exactly how much of a discount you are getting, so that you can take advantage of other people’s panic.”

Closed-end funds are an esoteric, misunderstood investment. Few people wake up thinking “I need to diversify into closed-end funds today,” so the funds are sold on the basis of a broker’s sales pitch.

At their best, closed-end funds can be a highly effective investment tool. At their worst, they can be highly leveraged, volatile bad deals.

Unlike a traditional or open-end mutual fund - which typically issue new shares whenever buyers put up cash - closed-end funds issue a limited number of shares, which trade like a stock, bought or sold minute-by-minute with a price driven by market sentiment.

A traditional fund’s price is always set at day’s end and equals the net asset value of the underlying holdings. A closed-end fund can trade at a premium or a discount to the net asset value of the holdings.

The market’s recent miseries have made discounts grow. In most conditions, the typical closed-end fund trades at anywhere from 2 percent to 10 percent less than its net asset value; today, double-digit discounts are common.

The issues you will want to investigate include leverage because many closed-end funds use riskier strategies to achieve their ends and the tightening credit market could smack down issues that borrow heavily. Also, look at the assets the fund holds and what is driving the discounted price. You would like to understand why the market is so unimpressed that it has let the share price drop below net asset value; it may be that the market has soured on the type of assets the fund holds, but it could be fears about leverage and more. (New closed-end funds typically are heavily leveraged, making them a poor choice; investors should always wait to see whether the fund will settle in at a discounted level rather than buying at the initial public offering.)

One other consideration is whether the fund might convert to open-end status if the discount gets too big. Activist shareholders have been known to petition for the change, which is a big-win for investors since making the change automatically captures the discount.

Chuck Jaffe can be reached at [email protected] or at Box 70, Cohasset, MA 02025-0070.



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