In previous articles (here and here), I've identified country Closed-End Funds (CEFs) that were trading at unusually large premiums to their net asset values. Because these CEFs consist of publicly traded stocks, I argued that premiums are irrational and must eventually go away. In this article, we'll look at an Asia CEF (IAE) that trades at an irrationally large discount.
Previously, I argued for selling the Aberdeen Chile CEF (CH) and buying the Chile ETF (ECH), which holds almost exactly the same stocks but doesn't have a premium. As the graphs below indicate, oversize CEF premiums are often bubbles that can be pricked by something as innocuous as a Seeking Alpha article.
(click to enlarge)
On the day the article was published, the premium was 29%. It has since dropped below 10%. I suspect it would have come down faster and further if it wasn't so hard to borrow shares to short. We made a similar trade with the Mexico CEF (MXF), as shown below. An irrational 10% premium eventually ground itself down to 0%.
A Trade on CEF Premiums Without Shorting
Since these articles were published, several people have asked me if there are similar long CEF trades one can make. There are indeed many CEFs that trade at very large discounts. The problem is these discounts are often chronic - they may persist for many years. So they won't be good for short-term gains. What we want is a CEF that trades at a discount that is outsized relative to its own historical discount. It's good to have a decent dividend too, so we'll get paid to wait for the discount to vanish. This screen turns up the ING Asia Pacific High Dividend CEF:
(click to enlarge)
Over the last three years, IAE has traded at an average premium of about 1%. Since this summer, it has slid to its largest discount since the great financial crisis, reaching a near 10% discount. That's not because IAE has bad management: on a NAV basis, IAE has generally outperformed Asia ex-Japan stock funds.
|Total Return %||3-Month||3-Year||5-Year|
|Pacific/Asia ex-Japan Stk||-9.32||1.78||2.91|
The Portfolio and the Method
IAE's portfolio consists of dividend stocks from the Asia Pacific region, with the country concentration shown below.
Its top holdings are:
|Westpac Banking Corp||2%|
|China Mobile Ltd.||1%|
|PT XL Axiata TBK||1%|
|PT Indo Tambangraya Megah||1%|
|Mega Financial Holding Co., Ltd.||1%|
|Taiwan Semiconductor Manufacturing||1%|
|PT Indofood Sukses Makmur TBK||1%|
|HSBC Holdings Plc||1%|
|PTT Public Co Ltd||1%|
IAE uses a "buy-write" strategy on roughly half its portfolio, writing calls on the broader Asian market indices. Using the proceeds from this, as well as stock dividends and other gains, it pays an 11% quarterly distribution. It is important to note that the distribution is not a dividend - it's mostly gains that are returned back to you. Last quarter's distribution of .35 comprised .0604 of income and 0.2947 return of capital.
Additional disclosure: I am also short CH.