Rivernorth Core Opportunity Fund: Capitalizing On CEF Pricing Inefficiencies

Sep.22.11 | About: NFJ Dividend&Premium (NFJ)

As most Seeking Alpha readers know, closed-end funds (CEFs) are mutual funds that are traded as a security on an exchange and have a limited number of shares (as opposed to open-end funds that have unlimited shares). A very good primer on CEFs can be found at Wikipedia.

CEFs contain both a net asset value (NAV) that reflects the true value of the underlying securities owned by the fund and a market price, which is the price at which the fund is actually trading. If the market price is above the NAV, the fund is trading at a premium to its NAV with investors paying more for the fund than it's actually worth; if the market price is below the NAV the fund is trading at a discount, with investors not willing to pay 'full price' as represented by NAV. The only way to definitively realize a discount is for the fund to liquidate or to convert to an open-end mutual fund which trades at NAV by definition.

The discount or premium of a CEF can be determined by a myriad of factors including manager, amount of leverage, expenses, composition of portfolio, performance record, market sentiment and others. What is interesting, however, is that many funds tend to run between bands of premium and discount values over time (Bollinger Bands are a good analogy). It would seem then, that there should be some type of strategy that can take advantage of the mean reversion tendencies of CEFs.

While compiling and then following a list of CEFs that tend to exhibit the strongest mean reversion tendencies is one possible solution, there is an easier way to skin that cat. Rivernorth Funds started the Rivernorth Core Opportunity Fund (RNCOX) at the end of 2006 to make opportunistic investments in CEFs. From their fact sheet, "[t]he Fund's Advisor believes that opportunistic, discount-based investments in closed-end fund shares can potentially earn excess returns over the closed-end fund's benchmark index."

It is a "core" fund as the managers invest in both equity and fixed-income CEFs. They have the ability to vary the allocation between equity and fixed-income and have a particular focus for purchasing the funds at the lower end of their historical premium/discount ranges. Expense are high for an allocation fund at 1.45%, plus the expenses of the underlying funds. This, however, is the price of admission to the only fund I could locate employing this strategy (I would appreciate reader input into others that may exist with this niche strategy).

A prime example of this strategy can be found in the fund's investment in NFJ Dividend, Interest & Permium Strategy Fund (NYSE:NFJ). NFJ traded at a discount of 18.9% on September 30, 2009. This was a drastic drop from the average discount which was closer to 10%. In fact the current average discount of the fund is about 10%. Purchasing the fund at so far off the mean fits right into the premium/discount inefficiency strategy. By September 30, 2010, the discount had narrowed to 14%. This represented a narrowing of the discount by 5% which, from a market neutral perspective, could lead to outperformance of a benchmark.

Performance has been pretty good as compared to the Blend index that the fund uses (60% S&P 500 and 40% Barclays Aggregate Bond Index). Detailed results can be found her. As far as the managers, I really have no opinion although it is interesting to note that Jeffrey Gundlach, who has been called the 'King of Bonds' and mentioned as occupying the same rarified air as Bill Gross, saw fit to contract with Rivernorth to manage part of their Strategic Income Fund.

All in all, Rivernorth Core Opportunity presents an interesting option for those investors who like the idea of playing the closed-end fund premium/discount phenomenon without having to monitor many funds on a daily basis. RNCOX is currently closed to new investors but it may be worth adding to your watchlist if you like the strategy. Who knows, perhaps someone out there will launch a competitor?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long RNCOX and have no plans to liquidate my position in the next 72 hours but I may increase my position.