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Registered investment advisor, closed-end funds, contrarian, CFA
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Summary: Many closed end fund (CEF) investors look at the current share price premium/discount relative to a CEF’s historical average prem/disc as a predictive investment tool. The thinking is that over time the current prem/disc should gravitate towards its historical average prem/disc. As a result, the greater the deviation from the historical average prem/disc, the greater the potential relative share price appreciation in re-establishing that relationship. Five CEFs with the greatest deviations from their historical prem/disc offer investors the potential of an average price appreciation of 13%.

An Important Investment Tool: Like any investment metric, “gravitation to the mean” is one of a handful of tools that has proven reliable over time for CEFs. It can be helpful in identifying undervalued CEF share prices. The graph below plots 644 CEFs comparing the current prem/disc to their historical average. There appears to be a meaningful association between the current prem/disc and the historical average (R^2= 43).

click to enlarge

Mean Gravitation Screen: The CEF universe was screened for the following factors: 1) At least 10 years of operating history; 2) Over $100 million of total assets; 3) An expense ratio no greater than 1.5%; 4) No auction rate preferred stock; 5) No world equity fund types.

Five Largest Current Discounts to Historical Average: The table below illustrates the five CEFs that generated the largest difference (spread) between their current prem/disc and their historical average. Noteworthy is that 4 of the 5 CEFs don’t employ leverage; the one that does, manages to do this in a modest fashion.

The bottom line is: on average, these five CEFs' share prices could increase 12.6% if their respective share prices again gravitated to their relative historical means.

While it makes sense to buy a basket of these stocks, BLU is the CEF with the greatest price appreciation. If the equity markets recover, the CEF discount will tend to narrow rapidly.

Disclosure: BLU