With the broader markets looking technically stronger with each passing day, investors should also start looking at equity closed-end funds (CEFs) that will take advantage of a continued up move in the markets, particularly the smaller cap market. The fourth and first quarters of the year tend to be seasonally strong and baring any more global debt crisis events that turns the market back on its heels, investors should look at some "risk-on" CEFs for appreciation as well as yield.
Leveraged CEFs are "risk-on" funds. And one of the most undervalued is the Royce Value Trust (NYSE:RVT). RVT is a global small cap fund that uses about 19% leverage to juice returns during up markets. RVT's benchmark, even as a global fund with about 29% non-U.S. investments, is the Russell 2000 small cap index. Instead of owning 2,000 stocks which make up the index, the fund narrows its holdings down to about 570 securities which includes fixed-income securities. This makes the fund plenty diversified. Here are RVT's statistics as of 11/10/2011.
- Current Market Price: $12.26
- Current NAV: $14.44
- Discount/Premium: -15.1%
- Current Market Yield: 6.85%
- Current NAV Yield: 5.82%
- Market Cap: $967 Million Net Assets
- Expense Ratio: 1.38%
One of the reasons to own RVT is that it re-instituted its quarterly distribution late last year and has raised it twice since. Small cap stocks don't generally offer much in the way of dividends so the fund has set its distribution based more on the expected performance of its holdings rather than portfolio dividend income. During the bear market of 2008 and early 2009, RVT continued to pay overly generous distributions which just accelerated its Net Asset Value (NAV) erosion. This eventually forced the fund to suspend distributions after the first quarter of 2009 in an attempt to build back its NAV and the fund has languished at up to -15% discounts ever since.
Fast forward to November 2010 and with RVT's reinvigorated NAV up from about $6 at its low to about $15 or 150%, management reinstated a slight $0.03/share quarterly dividend which it has raised twice more to the current $0.21/share per quarter. That works out to a still relatively tepid 6.85% market price yield and the fund still shows a -15% market price discount to NAV. However, this strategy of slashing the distribution to build back a fund's NAV has been done successfully before and a perfect example would be the NFJ Dividend, Interest & Premium Strategy fund (NYSE:NFJ) which slashed its distribution also in early 2009 and then reinstated its distribution a year and a half later. NFJ's discount narrowed quickly from -16% to almost a premium in less than a year. RVT may be taking a slower road to upping its distribution but with a still exceptionally low 5.82% NAV yield, there is room to increase the quarterly dividend with a stronger small-cap market.
Coming off a volatile and negative third quarter, in which the fund's NAV dropped -25.2%, which was a bit worse than its benchmark Russell 2000 average due to the fund's leverage and global exposure, I believe the Royce Value Trust is now poised to take advantage of a sustained move back up in the small-cap stock arena. And if another distribution raise gets the fund back to its former distribution level of around $0.35 per share, I believe RVT will finally start to significantly narrow its discount as well. It should be noted that RVT's NAV will generally outperform the Russell 2000 during up market periods but can underperform during down market periods. But with a -15% discount already reflected in the fund and the Russell 2000 still down about -6.5% YTD, I believe the upside from here is significantly greater than the downside.
But don't just take my word for it. Here is some text from an article by Aaron Levitt dated October 25, 2011, from the online website Investopedia titled "Is It Time To Think Small?"
"Small-cap investing is one area of the market that active management can really pay off, and no one does it better than Royce Associates. The mutual fund firm has dedicated itself to all things small and runs a plethora of small-cap based mutual funds.
One of their more compelling offerings is its Royce Value Trust. The CEF is trading at -14% discount to NAV and has shattered the broad Russell index since its inception in 1986. $10,000 invested in the Royce fund at inception, would be worth about $98,000, today; had you picked the index, you would have about $31,000 less."
Note: Author Aaron Levitt is an independent investment writer and analyst living in State College, Pennsylvania. His work appears in several high profile publications in both print and on the web. Levitt is an advocate for long term investing with a global framework.
Disclosure: I am long RVT, NFJ.