Based on the current discounts versus the historical discounts, World Equity Funds (“WrldEqFnds”) are currently generating the largest spreads on a relative basis (see table below).
While not without its unique set of risks, Thai Fund (NYSE:TTF) may warrant additional investor consideration for the following reasons:
1. It is currently trading at an 18% discount and a -9.6% spread to its 3 year premium/discount making it the second deepest relative discount of the 5 WrldEqFnds (see table below);
2. Historically, TTF has gone through period of the stock trading at a discount to be followed by longer periods of it trading at a premium;
3. It has recently paid a distribution for a yield of 2%;
4. There is no leverage;
5. The expense ratio is a moderate 1.16%;
6. It has recently underperformed its comparable ETF cousin (see graph below) and may indicate an upward adjustment or it may provide some arbitrage opportunity between the two.
7. If TTF were to gravitate toward its 5 year average of a 2.1% premium, its stock price would appreciate approximately 25% without a change in NAV.
Holding Period and Risk: This investment has a two year holding period and investors must assume greater than average investment risk.
This investment is not without risk. Thailand has reeled from political unrest of the Red Shirt protests along with the resultant economic chaos. Thailand remains an important hub in the global supply chain and will unlikely relinquish that role to the Philippines.
Premium/Discount Metrics: There are numerous metrics for evaluating a CEF. One ratio preferred by investors is the premium or discount that a CEF stock trades to its underlying net asset value (NYSE:NAV). It is the equivalent of a price-to-book (book value per share) ratio that is favored by investors in financial stocks—where collateral is important—and companies with volatile earnings.
It’s All Relative: Absolute discounts can be misleading and can persist over a long period of time due to the nature of the underlying assets (which can range from very liquid securities to private placement).
The premium or discount can also change with the cyclicality or investor sentiment of the investment sector. So, when viewed on a relative basis, i.e. relative to their historical average, it presents a better baseline for determining a CEF’s attractiveness on this basis.
Gravitation to the Mean: Investors who rely heavily on premium and discount measurements subscribe to the “gravitation to the mean” thesis, i.e. over time the observations being measured will gravitate to its average. Ergo, those CEFs with a large discount in theory will appreciate on a relative basis as the stock moves closer to its average. There is a positive correlation between a stock’s premium/discount to its historical average to support this observation (R^2= 0.36).
Largest Current Discount Spreads: I scanned my CEF database for the 5 largest current discounts to average historical discounts to determine the 5 greatest favorable spreads.
The five largest spreads turned out to be WrldEqFnds located in region of political or financial instability. Four of the five CEFs were Asian of which two were Thai related. The remaining CEF was related to Spain.
Click to enlarge
Part of the reason for these divergences in current versus historical premium/discounts has been that many of the World Equity Funds enjoyed significant premiums during the ‘90’s. However, over time the large premiums went to small discounts to now even larger discounts.
In the chart above, in 3 out of the 5 cases, the discount spread progressively narrowed over the periods signed.
TTF has lagged the ETF and may warrant additional investor consideration for investment or arbitration purposes.
Caveats: While the premium/discount ratio is an important tool used by CEF investors in determining the relative attractiveness of a CEF, it is not without its flaws and shouldn’t be used exclusively. These flaws include a focus on absolute discounts, the nature, liquidity and valuation frequency of assets owned by the CEF, as well as secular changes in investors’ preference for a particular investment sector.
(Speak to your financial advisor prior to making an investment of this nature.)
Disclosure: Joe Eqcome currently does not own TTF but may be a future buyer of the stock.