Here’s an interesting factoid. Over the three years ending May 30, the average mutual fund that invested in domestic equities has provided an annual return of 13.30 percent.
Until you compare it to another return. The average closed-end fund has returned 17.03 percent annually over the same period.
That’s a difference worth exploring. While millions of people are familiar with open-end mutual funds, few know much about the arcane world of closed-end funds. Open-end funds issue and redeem shares at the net asset value per share of the fund. Closed-end funds issue a fixed number of shares and then let them trade on a stock exchange. Like their wildly popular brethren, exchange-traded-funds, these funds can sell at a premium or discount to net asset value. Unlike the burgeoning exchange-traded-funds, the premium or discount can be large.
Few know much about this world because it’s small. There are only 922 closed-end funds. Only 41 of them have assets of $1 billion or more. Many have less than $100 million in assets.
In an investment world dominated by multi-billion dollar open end funds, these funds don’t get much attention. They are too small for Wall Street to make money on, except when they are IPOs.
Therein lies opportunity. A broker friend, whom I have admired for more than 20 years, has worked this area as long as I’ve known him. Now retired, he recently sent a joyous email comparing the performance of all open-end funds with all closed-end funds, category by category.
The closed-end funds beat the open-end funds in every category and in each of three time periods--- three years, five years, and ten years. “This is a compelling reason,” he wrote, “to at least shop in the closed-end fund store.”
But it gets better.
There is a very good way to buy closed-end funds that are likely to do better in the future. Buy the most discounted funds in each category. You know when a closed-end fund is selling cheaply when it is selling at a discount to net asset value per share, an easily obtained fact. Basically, when you can buy a dollar of assets for 90 cents, you do it.
Buy cheap; sell less cheap. Here are some examples.
- The 154 closed-end funds that invest in domestic equities were recently selling at an average discount of 2.4 percent. But there were 34 selling at discounts of at least 10 percent. Central Securities (ticker: CET) is one of the five closed-end funds surviving from the ’20s, yet it was recently selling at a 13 percent discount to net asset value.
- The 67 closed-end funds that invest in international stocks were recently selling at an average 5.5 percent discount to net asset value. But there were 27 selling at a discount of 10 percent or more. Eight were selling at a discount of 13 percent or more. The Templeton Dragon fund (ticker: TDF) has done better than its peer group since inception in 1994, but it was recently selling at a 15 percent discount to net asset value.
- The 152 closed-end funds that invest in taxable bonds were recently selling at an average discount of only 1.4 percent. But 22 were selling at a discount of 8 percent or more. Western Asset-Claymore U.S. Trust for Inflation Protected Securities Fund (ticker: WIA), selling at a discount to net asset value of nearly 10 percent, recently changed its investment policy to allowing it to invest more in non-U.S. inflation protected assets.
Is this a slam dunk?
No. Many funds are selling at smaller discounts than in the past. More important, buying in this sector requires homework. Just as many stocks and bonds sell cheap for a reason, so do many closed-end funds. That said, the basic principles are very easy--- buy a dollar of assets for less than a dollar.
On the web:
Closed end fund association
Site-by-Site Closed End funds center