In a recent article covering Central Securities Corporation Common Fund "CET" on Seeking Alpha, the article's claim (article found here) was that the discount to Net Asset Value was significant and the trading price is currently understated due to the value of a private company with non-current valuation figures. After reading the CET related article, and specifically reviewing CET's discount to net asset value for the last several years, it is quite obvious that CET is trading at a substantial discount for more reasons than stated in the previously mentioned article.
The purpose of this article is to address if CET's discount to net asset value will actually converge to zero or remain at current market price levels. Highlighted on Morningstar's website, Central Securities Corporation Common Fund seeks capital growth through investment in common stocks, convertible bonds, preferred stocks, convertible preferred stocks, warrants, options, real estate or short term obligations of governments, banks, and corporations.
Before diving into the details, I wanted to cover a few basic reasons why a closed end fund might be trading at a discount (or premium) in general. One of the biggest reasons is the fund's marketability to the average long-term and yield hungry investor, and another reason could be as basic as the portfolio manager reputation or brand. I've covered a variety of reasons (including the reasons listed above) to why a closed end fund would trade at a discount (or premium) in my first article on Seeking Alpha, and it would be a great primer for this article (you can read my first article here).
Market Cap: $507.5mil
Distribution Rate: 2.28%
Total Leverage Ratio: 0.00%
52 Week Range: $19.74 - 24.72
Current Market Price: $21.85
Expense Ratio: 0.79%
Considerations before buying CET
- Discount to NAV - CET currently trades a discount of -17.53%, which definitely looks like a reason to dig deeper for a potential buying opportunity, however, this fund has traded at a -17% discount for a very long time (15+ years), dating back to the year 2000. Generally speaking, buying discounted closed end funds are highly sensitive to recent pricing inaccuracies, and not long-term pricing inaccuracies, which may in fact signal that buying this closed end fund for the discount is not a strategic buying opportunity.
- Plymouth Rock Company Is Not Completely Holding Down CET - The recently published article stated that one of the companies in CET's portfolio is understated and therefore pricing CET's market price lower (to the current discount levels), however, this is very hard to believe since Plymouth Rock Company makes up 18.08% of CET's portfolio and the fund is trading at a discount of -17%. After running the numbers, it is highly unlikely that a "correctly-stated" pricing of Plymouth Rock Company would cause the -17% discount to converge to zero simply because the portfolio weight is not that substantial to drive such a large discount to net asset value.
- A 2.28% Distribution Rate is Very Unattractive - One of my main closed end fund filters is the distribution rate and if the distribution rate is lower than 8% it is automatically disqualified from my analyses, or investment ideas, because the yield is simply not worth the lost payout (in dividends) achievable with alternative highly yielding funds (for example, take AllianzGI Convertible & Income II Fund NCZ, that yields about 11% and trades at a tighter premium/discount to net asset value compared to CET. Read my article on NCZ here). So, what I am really saying here is, the distribution rate can definitely drive a market pricing inaccuracy simply due to the fact that investors are seeking a reasonable yield in closed end funds (regardless of the fund's investment objective), which CET does not currently market to investors.
- Distribution Frequency - CET distributes dividends semi-annually, which compared to other closed end funds, is not frequent enough. I explain the importance of distribution frequency in almost all my articles published on Seeking Alpha and in this case, the investor is locked in for several months before seeing the payout, which decreases reinvestment rates, increases investment holding periods, and overall, leads to less yield in addition to poor fund performance.
- Distribution Composition - CET's main distributions are long-term capital gains and fund income. From a yield and growth perspective, I see this being a sustainable distribution composition given the fund strategy, however, from an investment longevity perspective, I would prefer seeing a closed end fund's payouts composed of fund income to guarantee that the fund can maintain a consistently yielding portfolio asset allocation. Long-term capital gain payouts don't exactly look long-term to me. For funds like CET, any Return of Capital (ROC) would bucket CET into the "do not invest" bucket, since funds like CET are not supposed to be distributing the funds they are supposed to be using to grow and distribute income distributions with. There are some funds that are solely ROC funds, however, CET and other funds with similar strategies are not to be mistaken for those types of funds (a good example of an ROC distributing fund is ETV, where the ROC distributions are explained. Read that article here).
- The Expense Ratio is Very Low - For a fund that invests across common stocks, convertible bonds, preferred stocks, convertible preferred stocks, warrants, options, real estate or short term obligations of governments, banks and corporations (highlighted on Morningstar), I would expect the fund to have an expense ratio in the 1.70% range. In this case, the fund management seems to operate very efficiently, however, this raises the question of: Is the fund management operating effectively? From an investor's perspective, wouldn't it be more appealing to see a better performing closed end fund than a fund with a lower expense ratio performing at a mediocre level? The answer to that question is most likely yes, and that most investors would compensate strong performance for a reasonable return. I don't see how CET would be considered a strong performer at current performance levels.
- Portfolio Positions - Based on Morningstar's CET portfolio holdings (the Equity View of the top 25 holdings), this portfolio doesn't exactly indicate growth in 2014. CET has increased positions in Motorola Solutions, Inc. "MSI", Freeport-McMoRan Copper & Gold "FCX", Medtronic, Inc. "MDT", and JPMorgan Chase & Co. "JPM", and overall I'm not completely sure if this is my idea of performance driven positioning (data based on Morningstar.com).
Betalyst View: Overall, I don't really see the market buying opportunity here for CET. In addition to what was listed above, the Fund Manager is relatively unknown compared to the PIMCOs, BlackRocks, AllianzGIs, Nuveens, and other bigger asset managers. So, to bet that a fund's discount to net asset value is expected to converge to zero based on one position (in this case it was Plymouth Rock, a private company), it is highly unlikely to happen given the various considerations listed earlier, largely to do with the other fundamentals of the fund.