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Value investors should check different markets and financial instruments to find the best available deals. Closed-End funds (CEFs) trading at a discount to net asset value (NAV) are a source of potentially attractive investment ideas.

How do CEFs work? CEFs are mutual fund companies that buy and sell investments from a fixed pool of capital. Shares in CEFs are sold by current owners, often at prices that are lower than the sum of their holdings. When you buy a CEF, your investment pays expenses to the fund manager. The hope of CEF investors is that the return on their assets will exceed the fund manager’s expenses.

There is a relationship between discount and expenses that requires some thought. A fund is not cheap just because it sells at a discount. Instead, the fund must be discounted enough so that its fees are overwhelmed by its returns. Using math,* required return minus growth (r-g) can be calculated from the discount and expense ratios. High implied r-g values indicate that higher risk premiums are needed to justify the expenses of the fund given its discount. Low implied r-g values are justified with lower risk premiums.

Below is a table of CEFs with the deepest discounts with implied r-g calculated from discount and expense ratio:

Closed-End Fund

Ticker

Discount

Expense Ratio

Implied r-g

Equus Total Return

EQS

-44.39%

8.26%

10.3%

Foxby Corp

OTCQB:FXBY

-30.67%

2.28%

5.2%

First Opportunity Fund

OTCQB:FOFI

-26.05%

1.24%

3.5%

Canadian Gen Invmnts Ltd

CGI

-21.51%

1.30%

4.7%

Boulder Growth & Income

BIF

-20.70%

2.19%

8.4%

Boulder Total Return

BTF

-17.87%

2.19%

10.1%

Thai Fund

TTF

-18.04%

1.59%

7.2%

RMR Real Estate Income

RIF

-18.88%

2.41%

10.4%

Denali Fund

DNY

-17.01%

2.80%

13.7%

Diamond Hill Finl Trends

DHFT

-18.57%

1.42%

6.2%

Global Income

GIFD.PK

-16.70%

2.00%

10.0%

Central Securities Corp

CET

-13.44%

0.78%

5.0%

Gabelli Hlthcre&Well Rx

GRX

-15.95%

2.11%

11.1%

Japan Small Cap

JOF

-13.68%

1.44%

9.1%

RENN Glbl Entrepreneurs

RCG

-14.80%

5.47%

31.5%

Thai Capital Fund

TF

-14.72%

2.14%

12.4%

Royce Micro-Cap Trust

RMT

-15.01%

1.12%

6.3%

DCA Total Return Fund

DCA

-15.31%

1.90%

10.5%

Determining an appropriate risk premium for different asset classes is something of an art. I arbitrarily chose 7% as a reasonable starting point. Equity CEFs with 7% or less implied risk premiums are worth looking into as value candidates.

Further research is required to determine if the fund’s underlying holdings are a value portfolio.

Foxby Corp (OTCQB:FXBY) holds mostly US large cap names like Apple (AAPL), Amazon (AMZN), Berkshire Hathaway (BRK.A), and Google (GOOG). Buying FXBY is like buying these companies at a discount.

First Opportunity Fund (OTCQB:FOFI) holds mostly finance companies. Its holdings are mostly small cap stocks.

Canadian General Investments ((CGI)) is listed on the Toronto exchange and is diversified across different sectors, with its highest allocation to basic minerals. This fund pays a 5.77% dividend yield.

Diamond Hill Financial Trends (DHFT) invests in US companies, primarily in financials. Its holdings include JP Morgan Chase (JPM), Wells Fargo (WFC), and US Bancorp (USB).

Central Securities Corp (CET) invests with a long-term horizon, resulting in a low 7% turnover. Its holdings are primarily large cap stocks, with many holdings in technology and industrial stocks. The portfolio contains Agilent (A), Intel (INTC), and Murphy Oil (MUR).

Royce Micro-Cap Trust (RMT) Holds micro-cap companies primarily in the United States. It pays a 6.4% dividend, and offers micro-cap exposure at a discount. Investors who attempt to buy micro caps will find that they will have to pay high prices because the bid-ask spreads of these thinly-traded companies are wide.

* Here is the math where P is the market price of the fund, NAV is the market price of the fund’s holdings, r is the required return, g is the growth rate, E is earnings, and f is fees. The discount to NAV is 1-P/NAV.

P = E/(r-g+f) , NAV = E/(r-g)

P/NAV = [E/(r-g+f)]/[ E/(r-g)]

1- P/NAV = 1-[E/(r-g+f)]/[ E/(r-g)]

r-g = -f(P/NAV)/(1-P/NAV)

Source: Closed-End Funds Trading At A Discount