In the second half of our two-part interview, asset manager and author Scott Schultz discusses how he evaluates which closed-end funds are on sale, and why they would make good investments. Part 1 can be found here.
Scott Schultz: Now, let’s go offshore. I think there are a whole lot of problems going on in Europe now, and it’s in the news regularly, and for the most part, I surely can’t argue with it.
But I’m a history buff, and I look at one country that comes and goes with wars and that, but Switzerland tends to really never get embroiled in any of it. Right now, the Swiss Helvetia Fund (NYSE:SWZ), trades on the New York exchange, and this fund has as its objective long-term capital appreciation through Swiss-owned companies.
OK, nobody really is in Switzerland—they don’t have any companies, right? Wrong. Top holding, Nestle (OTCPK:NSRGY), 20.6%. Novartis (NYSE:NVS), major drug company. Roche Holdings (OTCQX:RHHBY), medical. UBS (NYSE:UBS). You were looking there, and that’s almost half of the fund.
This fund is 87 or 88 cents on the dollar, and they are Swiss companies. So, I look at that and say if I want to be overseas, Switzerland is not a bad place to be.
So then, I’ll roll into a fixed-income product. Some people, they want income. Our current holding there would be the Morgan Stanley Emerging Markets Debt Fund (NYSE:MSD). Now, that fund right now is paying about 6.1% interest—double the 30-year Treasury. It’s also trading at 90 cents on the dollar, and it’s backed up by some very interesting securities.
Petroleos De Venezuela pays roughly 8.5% interest. The government of Argentina, 7%. Brazil, Russia, Mexico, Philippines. All around, this is a very, very diversified global fund. $338 million in assets. I’m getting 6% [yield], but I’m buying it at 10% off.
One thing about fixed-income funds in the closed-end world, Kate, is that every 12% approximately, of a discount, equals 1% of real cash flow. So, this being 10% off makes that yield almost 7% in actual cash into the investor’s pocket, because they’re getting $1 of interest but they only put up 90 cents to get that dollar. So, that’s the advantage with fixed income.
Now, I’ve got a real flyer. I have it and I rarely ever gamble or take wild guesses, because there’s a four-letter word that I totally hate in the investment world, and that’s called risk. I simply don’t like it.
I look at a fund, and this one is called First Opportunity Fund Inc., (FOFI.PK). It’s over the counter.
I look inside this fund, and as you noted earlier, I was able to name some really high-quality investments. I look at this and I see Johnson & Johnson (NYSE:JNJ) is about the only thing worth a darn, and a little bit of Wells Fargo (NYSE:WFC). But there’s a special story here. The individual, at this time, who runs the fund, owns almost two-thirds of the fund.
The asset, it’s at a 28% discount. So just imagine starting a race with you up on the 28-yard line and I’m back at the goal line, and we run that 1,000 times.
What happens with closed-end funds, when it’s called a hostile investor or an activist, somebody who doesn’t like the way the current things are going, and they have enough muscle—i.e. they own enough shares—they can alter the board of directors. “Look, we don’t like what you’re doing. We have a major investment and we want you to change it. If you don’t change it, we’re going to take you over.”
So, that’s what’s called an open ending. They can get enough shares voted, and oftentimes it takes two-thirds of the shares outstanding, so if there are 10 million shares and somebody has roughly 6.8 million shares, they can, in certain cases, make a vote from the board of directors to say we’re going to liquidate all the assets today. All of a sudden, vavoom, you have net asset value. So, this one, if that were to occur, literally I could make for my clients 28% in a day.
So, there’s a fellow here—and again the fund has $246 million in it and there are 28 million shares—but most of those shares are one specific entity. There are roughly 12 to 14 different shell corporations this person uses.
It’s all legal. Nothing here is illegal by any stretch. But at the same time, closed-end funds, being different than open, they only have to report their holdings every six months but they can go to nine months, where a regular mutual fund, every quarter they have to send out prospectuses and all sorts of things. Closed-end funds are not hampered by that at all.
So FOFI, as I like to refer to it, is a speculative security, because if I can get a security that I think this man is going to continue what he does do—and I’ve been around him a while, he’s very successful at topping them, making them to go open—I have the opportunity for my clients to have a home run.
Now, closed-end funds by any stretch, you want to get walked, you want to get a single. You want to get hit by the pitch. It’s just getting on first base. It’s “Get me on base,” because at that point you have that inherent lead against anybody in the open-end funds arena, or frankly the individual stockholder.
If I wanted to buy Berkshire Hathaway A (NYSE:BRK.A), I’d have to pay maybe $116,000 to $118,000 for one share of the class A shares. However, if you go through the Boulder fund, going back to that, I can get Warren Buffett, 40% of the fund, at $15, $16, $17 a share.
Kate Stalter: Let me ask you something about this at this point. Is there any difference in how you would allocate assets into any of these funds, given the market volatility, or perhaps what you might enter into in a bull market versus a bear market? How do you view that?
Scott Schultz: That’s really good, and this is what I want to segue over into, away from the securities in the book, to what my firm does.
We offer essentially—technically, because we’re 401(k) friendly, which means we can operate 401(k)s and we have the administrative ability to do it.
One is a money market, which of course we don’t report that. We call it hybrid because say something happens with you, Kate, in particular. Aunt Millie passed away and she was very fond of General Motors (NYSE:GM), or whatever it was, and she gave you shares. “I never want to sell these shares but here’s my other cash I get.”
So, we’re stuck. We have to hold the General Motors because you have this affinity to it. We don’t want to be blamed for it going down, and we don’t want to take the credit for it going up. You would then take the other assets and invest it in closed-end funds.
So, we have those, and we have individual stocks. We don’t really get in there. We have five offerings mostly: Domestic growth, foreign growth, income, asset allocation—which means it’s a mixture of them both—and hybrid, where we can be across the spectrum of the globe. So, we have five different pieces.
So, for instance, if you are a 401(k) investor, you could put 20% across the board, and each time you made a contribution, that’s how it would go.
If you were an individual investor, Kate, and you came to me and said, “Scott, I have $500,000, or say, $100,000 and I really don’t want to take a whole lot of risk. What do you think?” Well, right now if you want to buy the 30-year Treasury, you’re only going to make 3%. It’s a pretty difficult proposition, but you know that the government, well you think it’s going to be there.
You don’t want to be in Europe. That’s why I have Switzerland. I don’t have a whole lot of confidence that the euro is going to survive. That’s just me.
I don’t like risk, so I tend to steer clear. I warn people, be that as it may. So, we can pick the level of risk and ratchet it and/or divide it for you.
I want like 80% fairly safe. To me, that would be asset allocations where we have a split of fixed income versus securities that are individual closed-end funds, be it foreign, domestic, or both. That’s how we get around to the satisfaction comfort zone, so when Kate sleeps at night, she doesn’t have to worry about it.
Kate Stalter: Right, well that’s always good. Scott, you’ve given us a lot of information today. Wrap up by telling us: What is the best way for the do-it-yourself investor to get involved with closed-end funds?
Scott Schultz: That’s a good one. I would hope that they would consider buying my book, Scott Schultz’s Guide to Closed-End Funds.
There are also a couple of Web sites that we mention in the book. At CEF Connect , you can start sorting there by discounts and premiums.
We’ve explained what a discounted premium is compared to net asset value. Now you can look at all the funds. What’s the fund that’s the biggest, the cheapest on sale?
For instance, right now there is one at roughly 60 cents on the dollar. The Equus Total Return Fund (NYSE:EQS) literally is selling for 59 cents on the dollar. Now, it’s not a fund I would recommend, but when I would look at FOFI as the fifth largest discount, which is the one I have, I sort of chuckle. But, it’s there, and you can sort just on that site.
A second site is the Closed-End Fund Association. Very good information there.
Another firm, Capital Link. They are the primary producers of an annual conference where many funds get together for investors to co-mingle with the managers, get explained all their questions, get ideas, interact with people that normally they wouldn’t get a chance to.
So, those sites themselves I think would be a good do-it-yourselfer, a good primer...but only after they read my book.