A System for Trading Closed-End Funds

How do you know if a cheap stock is a good value, or cheap because it is bad? If you understand the business very well, you can do your own research. A lazier and more common method is to check the opinions of people who should know, such as analysts and insiders.

Closed-end funds (CEFs) often trade at a discount, providing a quick way to find seemingly cheap stocks. They usually aren't followed by analysts, however. They also charge fees, which can undermine their cheapness.

I've been testing a system for trading CEFs that aims to find cheap CEFs while avoiding those that are cheap because they have problems. The system has two parts. First, it requires recent insider buying. CEFs usually aren't followed by analysts, so insider trading provides the qualitative indication of the health of the fund. Second, it divides the discount (as a positive number) by the fees. The discount/fee ratio shows whether the stock is cheap (bigger is better).

I've tracked the performance of this system at Marketocracy for over 2.5 years. In that time, it has outperformed the S&P by an annualized 14%, with a turnover rate of under 50%. It is a simple and low-labor trading system.

You can review more performance statistics on the fund's public page.

The Marketocracy fund is not a purely mechanical implementation of the system: I don't automatically buy the CEFs with the highest discount/fee ratio or most insider buying. I look at diversification and use my own judgment of what type of investment will do best. The fund never holds CEFs with a discount/fee ratio below 5 and no recent insider buying, however. Note that Marketocracy's performance figures include fees.

Here is a list of some CEFs that currently qualify as buys in this system. I've included the Morningstar rating when available, although that's not a part of the system I've been testing. the "Insiders" score is my rough and somewhat subjective estimate of the strength of recent insider buying (3 is best).

Source for discount and fees: etfconnect.com

Comments

[George Spri...:]

Interesting system, Ben.
What do you use as a sell indicator?

2008 Mar 03 10:03 PM

[brad linch:]

looks good. thanks. could you add the symbols?

2008 Mar 03 10:19 PM

[oldman:]

What is Dis./Fees?

2008 Mar 04 03:35 PM

[bsharvy:]

The symbols are given in the charts, e.g. ADX. Dis./Fees is the discount/fees. It's the basic way of measuring value in this system. Automatic sells in this system happen if the dis/fee ratio falls below 5, or there has been no insider buying in over a year. Sells that involve more judgement are certainly possible, for example if a CEF had a dis/fee ratio of 6 and insider buying 9 months ago, and its strategy was already held by another CEF, I might dump it and buy something else. The basic idea is to narrow the possibilities down to a small pool, and then use best judgement within that pool. The best performing CEFs that have qualified in this system have been emergining market stocks: LAQ, CEE, ETF for example.

2008 Mar 04 11:14 PM

[equal future:]

I am reading your system, what concerns me is loss of share value DNY, although the yield especially in the reit closed end funds is excellent, DNY has lost close to half its value, this is true for many cefs, great yield, lousy stock performance, what do you rec. for a modest yield and a modest stock performance

2008 Mar 07 11:32 AM

[bsharvy:]

I expect modest yield and modest performance from ADX, MXF, and SWZ. I own the latter two. UTG is probably safe too. A lot depends on which sectors will do well, and that's very muddy right now. Will energy continue to do well, or is it just spiking because it's a safe haven? Is commercial real estate bottoming? These are hard questions to answer right now.

2008 Mar 17 07:03 AM

[richk98:]

Makes sense, how accessible and how timely are the insider buy/sell filings? Where are these posted?

2008 Mar 24 07:17 PM

[bsharvy:]

insidercow.com, finance.yahoo.com, money.msn.com....there are many sources for insider trading.

2008 Mar 25 02:10 AM

[YaddaMinski:]

Let's check back in 10 years and see how this strategy performed. 2.5 years is too short a time to assess an investment strategy.


On 2008 Mar 04 11:14 PM bsharvy wrote:

> The symbols are given in the charts, e.g. ADX. Dis./Fees is the discount/fees.
> It's the basic way of measuring value in this system. Automatic sells
> in this system happen if the dis/fee ratio falls below 5, or there
> has been no insider buying in over a year. Sells that involve more
> judgement are certainly possible, for example if a CEF had a dis/fee
> ratio of 6 and insider buying 9 months ago, and its strategy was
> already held by another CEF, I might dump it and buy something else.
> The basic idea is to narrow the possibilities down to a small pool,
> and then use best judgement within that pool. The best performing
> CEFs that have qualified in this system have been emergining market
> stocks: LAQ, CEE, ETF for example.

Jul 29 08:43 PM