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Some of the biggest potential bargains in the stock market occur in highly illiquid securities. Because the securities are illiquid, they are usually ignored by big institutional investors, and most of the trading is done by retail investors or insiders. These securities can also be a value trap if there is a "catch" that explains the low valuation.

An interesting special situation now is the Foxby Fund (OTCPK:FXBY). This is a closed-end fund that is currently selling at a 26% discount to its net asset value. Theoretically, you could earn a 35% return in one day, if the fund simply liquidated itself.

FXBY is currently selling for 74 cents on the dollar. Most of the stocks in the portfolio are highly liquid securities. So if the fund simply sold its entire portfolio at market value and distributed that cash, you would earn a 35% profit.

By far the largest holding in the FXBY portfolio is Apple Computer (AAPL). In the most recent reported holdings to the SEC (3/31/2012), shares of Apple made up 23% of the FXBY portfolio. The other fund holdings are also very solid companies with great global franchises.

Here are the top ten holdings as of May 31, 2012 from the company web site. These ten holdings make up about 74% of the total fund assets:

FOFI- Top Ten Holdings as of May 31, 2012

  1. Apple Inc.
  2. Amazon.com Inc
  3. The Home Depot, Inc
  4. Franklin Resources, Inc
  5. Google Inc
  6. Berkshire Hathaway, Inc Class B
  7. McDonald's Corp
  8. Wal-Mart stores, Inc
  9. The Proctor & Gamble Company
  10. United Parcel Service of America, Inc.

Overall, if you buy the Foxby Fund today, you are buying Apple Computer along with a group of other great businesses at a 26% discount to net asset value.

But now that I have told you about the positive aspects of purchasing FXBY, let me discuss some of the potential "catches" or risks.

1) High Expense Ratio in Percentage Terms: FXBY is a tiny fund with about $6 million dollars in assets under management. In absolute terms, the management fee and fund expenses were actually very low in 2011. The management fee was only $22,750 and the total fund expenses were $92,369. But because of the fund's tiny asset base in 2011, the fund expense ratio was about 2%.

2) Fund Management Changes: The fund manager, Bassett S. Winmill passed away on May 15, 2012. An interim investment management agreement has been signed with CEF Advisors which will be in effect for 150 days. A special meeting of shareholders is scheduled prior to October 12, 2012 when a new investment management agreement will be voted on. The new agreement will contain several changes (not yet disclosed in detail) including an increase in the investment advisory fee.

3) Checkered History: In November 2008, there were days where FXBY traded at discounts to net asset value of over 50%. The fund had terrible performance in 2008, when its net asset value dropped 63%, and its market price fell 74%. Since then, performance has improved. Year to date for 2012, the NAV is up 14.6% and the market price is up 22%. The recent good performance is partially due to the large holding in Apple Computer.

4) No Recent Insider Buying: If there were short term plans to open-end this fund, I would expect to see some insider buying. I have not seen any insider buying of FXBY in quite some time. There is very low institutional ownership (under 5%) and I am not aware of any CEF activists with a position in FXBY.

5) Highly Illiquid: FXBY trades on the Pink Sheets "by appointment". Its average daily volume is only 3,000 shares a day, or a dollar volume of about $4,500. In order to buy a decent sized position, you would have to make many small purchases over time. For this reason, you would want to have access to free commission trades, or trade on a per share basis instead of per order.

Overall, I see FXBY as an interesting "special situation" because of its low valuation and exposure to solid companies such as Apple Computer at a substantial discount. But since there is no immediate catalyst to force a narrowing of the discount, it should be viewed as a long term investment.

We will have more information about future changes to the fund after the proxy statement is published for the upcoming shareholder meeting. This statement is expected to be released in the third quarter of 2012.

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

Source: A Little-Known Way To Buy Apple Computer For 74 Cents On The Dollar