Seeking Alpha
Deep value, long/short equity, event-driven, research analyst
Profile| Send Message|
( followers)  

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

OTCPK: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 (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Berkshire Hathaway (NYSE:BRK.A), and Google (NASDAQ:GOOG). Buying FXBY is like buying these companies at a discount.

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

Canadian General Investments ((NYSE: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 (NYSE:JPM), Wells Fargo (NYSE:WFC), and US Bancorp (NYSE: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 (NYSE:A), Intel (NASDAQ:INTC), and Murphy Oil (NYSE: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