SGF Offers Investors A 14% Discount To NAV, And A Very Simple Pairs Trade

| About: Singapore Fund (SGF)


SGF offers investors a simple way to invest in Singaporean equities at a 14% discount.

Country risk/stock specific risk can be easily removed via a pairs trade with the MSCI Singapore Index.

The discount to NAV should close as the stock liquidates itself at 100% of NAV, and pays holders.

The Singapore Aberdeen Fund (NYSE:SGF) is one of the simplest investments you can make. The goal of this piece is to; (1) highlight the investment, (2) offer an easy pair's trade that should eliminate much of the risk, should you choose; and (3) highlight a clear catalyst that will help close the discount to NAV.

#1. What is SGF and why should you own it?

SGF is a closed-end fund that seeks long-term capital appreciation (who isn't?) through investments primarily in Singaporean equity securities. If SGF's performance was a game of hide and seek, they would be considered a great seeker of returns but a terrible finder. Actual performance has draggled (it really is a word) the closest benchmark, the MSCI Singapore Index by 1.2% since the start of the 90's. The gap is almost perfectly explained by SGF's higher expense ratio, indicating these particular stock pickers are not worth their paycheck.

Source: Aberdeen

The market has not been a fan of this under-performance or of Singapore and other emerging markets for that matter. As funds have flowed out of emerging markets, CEF's such as this one have seen widening discounts to NAV. But, an increasing discount to NAV should be appealing to a value oriented investor; it means you get to buy dollars for less than a dollar, in this case about $0.85 on the dollar.

The historical average discount is 9.5%, significantly less than the current 14% discount, which is notably also the largest spread since 2010 (see below). The larger the discount the more appealing this investment becomes. Keep in mind that with higher management fees, a less than stellar track record, and Singapore being a market that sees little investor enthusiasm I do not expect the fund to close the entire gap to NAV, outside of a total liquidation event, especially as CEF's typically receive (albeit deservedly) a discount to NAV. I would reconsider my stance on this investment when the discount returns to the 9 to 10% historical range, outside of that I am happy to hold indefinitely, and recommend it to others, particularly given its ~10% dividend (more on this later).

Source: Morningstar

#2: Making it a pairs trade

Source: Morningstar

While SGF, its discount to NAV, and the MSCI Singapore index all move hand-in-hand, a widening discount to NAV creates an opportunity to purchase something for less than it is worth. The correlation between NAV and price is common sense rather than spurious, as NAV and price should approximate one another, and blown out spreads should revert to the mean.

The close movement between the MSCI Singapore ETF (NYSEARCA:EWS) and SGF is explained by the fact that they both own a similar basket of stocks. Which brings us to point #2, the MSCI Singapore Index is the offset for SGF, which allows for a cost-effective pairs trade that allows the mitigation of further weakness in emerging markets economies, due to U.S. fiscal policy, or various other reasons. With the two hedged we are mostly left with a raw discount to NAV, which should close (more on this in a bit).

If we compare the top ten holdings of the MSCI Index and the SGF fund we notice very similar constituents, in fact the two share five holdings in their Top Ten lists, and sector weights are very similar as well.

SGF Top Ten Holdings:

Source: Aberdeen

SGF Sector Weightings:

Source: Aberdeen

MSCI Singapore Top Ten Holdings:

Source: MSCI

MSCI Singapore Sector Weightings:

Source: MSCI

#3. Closing the gap - catalyst

Over the year's SGF management has increased its toolbox of methods to close the gap this includes repurchases and distributions. SGF aims to achieve steady distributions to shareholders and it achieves this through a mixed return on capital and if there is not enough then a return of capital. The difference being one is money they earn via investments and one is a self-liquidating mechanism that reduces invested money (and NAV), only a return on capital is actually real earned income. For example in a recent distribution they paid $0.27 per share, but half of this was them giving you back your money, in a down year such as this one the majority of the distribution will be a return of capital.

When the price of SGF shares are at parity with NAV a return of capital is break-even, although depending on your tax situation this result will vary. When SGF shares are trading at a discount to NAV, like they are now, this return of capital is profitable as they are cashing in dollars' worth of investments at $0.85 and paying you back in full dollars. Effectively they are closing the spread completely on the amount they pay-out. This acts as a catalyst; even if the discount to NAV does not close you still receive some of the spread while you wait, with further upside if the spread moves to its historical level. Self-liquidation in a closed-end fund is a very nifty way to receive an otherwise nearly unattainable 100% of NAV.

Source: Morningstar

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.