10 Closed-End Funds Trading at Large Discounts

Closed-end funds differ from open-end mutual funds in that the size of the assets under management does not change when investors buy in or sell out. So when you want to buy a share in a closed-end fund, you have to buy it from someone who already has one (not the fund manager, as you would for an open-end fund). As such, many closed-end funds trade like regular stocks on the NYSE.

Often, however, many of these funds trade at discounts to what they actually own. For example, here's a list of some of the largest discounted funds currently on North American exchanges:

There are many papers devoted to the topic of explaining the discounts (and premiums) at which closed-end funds trade. These discounts represent an opportunity to buy the assets under management for pennies on the dollar. Often these assets represent public companies that an investor can buy himself. Therefore, arbitrage opportunities, which we've discussed here, can emerge. However, in most cases the investor will not know the changes the fund has made to its portfolio until after the quarter is over, which can make his arbitrage attempts difficult if there's a lot of churn.

In other cases, the fund's assets are not invested in public companies. As such, the market values of the holdings are unknown, and so investors often punish the market value of the fund, creating a discount, since the fund's holdings are illiquid and of relatively unknown value.

Value investors may appreciate the fact that they can buy assets for a discount in the form of closed-end funds, but they should always do their homework (i.e. read the fund's quarterly reports) to ensure they understand what they are buying.

Comments

[Ganesh Sastri:]

Watch out for high expense ratios.
Eg. EQS has 8.62% expense ratio and Management fees. Why would any body pay that kind of expense. You come after Fund expense if any thing is left.

MSP's discount is nowhere near 88%. It is just 12%. Expense ratio + management fee is 1.7%.

2008 Jul 28 10:44 AM

[mikecupertino:]

I don't think the fact that MSP is trading at a discount is a mystery. Since inception (4/27/05), total return to holders of the fund including dividends has been -4.2% per year. The fund managers have a knack for picking losers and are being appropriately rewarded for that talent.

2008 Jul 28 01:06 PM

[mikecupertino:]

Mr Karsan recommends that investors should "always do their homework". He needs to take his own advice.

One of the funds on this list, MGB, is a highly leveraged junk bond fund. This seems to me to qualify as a highly toxic investment. Another fund on the list, GIFD, has, according to Morningstar, a 5 year annualized market return of 2.1%. In other words, an investor would have done much better investing in a money market fund.

2008 Jul 28 01:25 PM

[Saj Karsan:]

Hi Mike,

Thanks for your comments. Please note that I'm not recommending these funds; I grabbed the list from a search of the most discounted firms on CEFA over the weekend. I'm simply saying they trade at discounts to what they own and represent potential opportunities for those interested in researching further.

If you've researched two of the firms and decided they're not for you, that's fine, it's exactly the process I'd recommend. I haven't researched them; the article was meant to introduce the concept of closed-end funds to some readers of my blog.

2008 Jul 28 04:02 PM

[Saj Karsan:]

Mavericks and Ganesh, thanks for pointing that out. My apologies, something must have gone wrong with my search, and I should have checked something as blatant an outlier as it was. I have updated my blog to reflect the stats as of tday, and seekingalpha should do the same soon. Thanks.

2008 Jul 28 06:30 PM

[whidbey:]

I holding some toxic trash, but I am getting 13% and 14% from them and the principal grows. Still, I would be elsewhere if I were not underwater.

2008 Aug 01 03:27 PM

[grunt0311rvn:]

Looking for low risk high income

2008 Sep 13 07:47 AM