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Many closed end funds are trading at above average discounts now. One of the best bargains for a vulture investor right now may be the RMK Advantage Income Fund (RMA). Last week I started buying into this fund at prices in the 1.10 range. RMA is not very liquid, so it may be best to use smaller limit orders when you buy it.

RMA invested in many complex mortgage backed securities. Its market price has been absolutely obliterated over the past year (down about 80%). On July 29, 2008, there was a change in fund management. Hyperion Brookfield Asset Management was appointed Investment Advisor replacing Morgan Asset Management, Inc. who is facing many lawsuits from irate investors.

I listened to a conference call from the new fund management. Their strategy going forward can be summed up as follows:

1) Dividend payouts have been drastically reduced to stabilize the fund NAV which had dropped precipitously. At the previously higher payouts, the NAV was rapidly shrinking toward zero, and management would soon be out of a job! But the reduced payout of $0.015 per month is still equivalent to a distribution yield of about 15%.

2) Hyperion has broken down the fund assets into three categories:

a) Bonds trading above 70 - these are the best quality issues with some appreciation potential.

b) Bonds trading from 20-70: These are probably the riskiest issues, since they have lost a lot of value, but still have more value to lose.

c) Bonds trading below 20: These are bonds that have already lost most of their value, so ironically they are less risky. If you look at the portfolio as of June 30, you will find many bonds have been marked down to 0.01% of par value. This is equivalent to 10 cents per $1000 in par value. Not much downside risk left! A lot of these bonds are income only issues that have most likely finished paying out, but there is always a remote chance they could start paying again.

Between July and August, Hyperion reduced the holdings of bonds trading in the 20-70 price range, and increased holdings in the >70 range. This means that the portfolio is much less risky now than it was earlier in the year, and is more oriented toward more liquid high yield securities rather than mortgage backed products.

Price Category Breakdown

 

  07/31/2008 08/29/2008
Price > 70 29% 54%
Price- 20 to 70 54% 32%
Price 15% 13%
Equities 2% 1%


 

3) When Hyperion took over the fund, there were sharp drops in the fund’s NAV.  It is clear that they marked-to-market the portfolio down in price. In cases where the bonds traded, they are using a bid price. In other cases they seem to be using highly conservative models which produce low ball values.

4) Many early investors in RMA have been selling in droves for a tax loss. Financial advisers are also dumping RMA to get it out of their client’s portfolio before they have to meet with them for the next portfolio review. This has caused the discount to NAV to increase dramatically.

At the end of Sept, 2007, RMA actually sold at a premium over NAV of 13.58%. Last Friday it sold at a discount to NAV of 34.10% (and even higher on an intra-day basis). This is a swing of over 47%. Ironically, the NAV now is much more conservatively priced than a year ago, so you get to buy RMA at a 34% discount to a low ball NAV.

This is clearly not an investment for widows and orphans, but RMA seems like a very attractive way for an IRA investor to bet on an eventual return to some normalcy in the financial debt markets in the next few years. But it may be safer to dollar cost average into the position in case the credit crisis deteriorates even further before the eventual recovery. There may also be further tax loss selling between now and year end.

Full Disclosure: I am long shares of RMA.

Source: RMK Advantage Closed End Fund is Worth a Look