Three Closed-End Funds of Funds

Recently a new closed-end fund containing other closed-end funds was created - the Cohen and Steers Closed-End Opportunity Fund (FOF).

This fund is large and originally raised around $460 million in assets. They haven't disclosed their portfolio yet, but have most likely purchased closed-end funds selling at a discount to NAV. I believe this fund is partially responsible for the shrinking discounts to NAV we have recently seen in many closed-end funds. Ironically, they are not permitted to buy other Cohen and Steers closed-end funds, which would explain why their UTF and RTU funds now have higher discounts to NAV than most other closed-end funds.

FOF currently sells at a premium of 3% over NAV and has a management fee of 0.95%, so I see little reason to buy it at this time. But it might become interesting if it ever develops a discount to NAV in the future.

But there is another fund - Adams Express (ADX) - that looks very interesting right now which offers a "double" discount to NAV. ADX is very similar to an S&P500 index fund and owns many of the top blue chip stocks- stocks like GE, AIG, BAC, MSFT and PFE are big holdings. ADX has a low expense ratio of 0.47% and currently sells at a 13.37% discount to NAV. But instead of holding a large energy stock like XOM, they own another closed-end fund PEO which also sells at a discount to NAV of 9.84% and has a low expense ratio of 0.54%. The top four holdings of PEO are large cap energy stocks- XOM, CVX, SLB and COP.

A good way of evaluating ADX is that you are getting a 13.37% discount on most of the portfolio, but you get a "double" discount on the energy holdings like XOM that are in PEO. The double discount percentage may be computed as follows:

DD= 1.0 - (.8663)*(.9016)= 0.2189 or a 21.89% discount to NAV.

This is very attractive, since the combined expense ratios of both ADX and PEO combined is only 1.01% which is lower than most individual closed-end funds.

There is at least one other discounted closed-end fund that owns other closed-end funds but it doesn't seem that attractive -- Boulder Total Return Fund Inc. (BTF) : Sells at a discount of 7.66%. Invests around 10% of its portfolio in about a dozen other closed-end income funds selling at discounts to NAV.

But the problem here is that the BTF expense ratio is 2.23% (not even including the expense ratios of the underlying funds). Way too high for me.

Comments

[Eric Boughton]

Interesting finds, George. I run a hedge fund that applies the strategy of buying closed-end funds at discounts to NAV, so I am pretty familiar with this area. Every single one of the closed-ends we bought in 2006 (about 30) saw its discount to NAV narrow (or disappear) by the end of the year. Intriguing possibility that the tail end of that could have been due partially to FOF. (Our hedge fund, Matisse Income Fund, is up 23.5% (net after all fees) since inception October '05.)

We have also seen a number of activist hedge funds purchase closed-ends at discounts, then sue the company to 1) convert to an open-end (discount disappears obviously), or 2) buy back shares at close to NAV. One typical example is Karpus, and their involvement with IMF. Our hedge fund is currently only $12 million, so we don't quite have the size to push the closed-end boards around like Karpus can.

Wanted to point out your "double discount" calculation on ADX is a bit misleading, however, given that PEO only makes up about a 5% position in ADX. Taking that into account, the net "look-through&quo... discount on ADX only goes up to about 14%.

[David Banash]

Eric,
Good point about weighting that discount calculation. I own ADX as well as CET another old closed-end equity fund. Taken as a group along with GAM and TY, these granddaddy equity CEF's really put a premium (no pun intended) on deep value, buy and hold portfolio selection. It's amazing that you can get them at sizable discounts at times but hey, everybody loves an inefficient market!

[George Spritzer]

Hi Eric-

If you re-read my blog article again, I did say that the "double discount" only applied to the energy portion of the ADX portfolio. Your 14% overall portfolio discount is about right however, and I should have also included that calculation to avoid confusion. The calculation would become much more confusing if PEO decided to buy some ADX because of the circularity.

[mjrmgs2]

George and Eric: Thanx for your informative memos.
The closed end funds ADX and PEO have a low cost tax basis because of appreciation since original purchase by the funds. This subjects purchasere to capital gains taxes on prior appreciation, when shares in the portfolios of the closed end funds are sold by the funds. Thus, purchasers' cost tax basis of the shares in the fund portfolios, when the funds are purchased, may be as much as 40% below the tax basis if the underlying shares were purchased directly. This tax detrement would not apply to pensions and IRAs.

Ray