Phil S

Why Central Securities Corporation Looks Attractive

OK, I see where the valuations of Plymouth Rock are listed on their site (easy to find under "Common Stock Appraisals"). I think that may be relatively new - I think I've poked around on that site before and not seen that.

You say the appraisal was done in early 2009 - anything more specific on the time frame?

Why Central Securities Corporation Looks Attractive

Re: expenses, turnover, and track record:

0.83% is decent as an expense ratio by equity CEF standards, but it's high in comparison to certain non-CEF alternatives (Vanguard, etc.).

2.53% *is* a low turnover, but here's a thought: If you divide the amount of money on which something was changed this year by the ER, it looks like the price of having this money managed is pretty high. i.e. For every $2.53 in turnover, you are spending about $0.83 in expenses/management.

Unless that $2.53 constitutes amazing decision making, really what you are doing by investing in this fund is buying a basically passive portfolio of stocks, with a somewhat high cost structure relative to the actual investment management that is going on. The track record may be solid, but how much of that is attributable to the decision to invest in Plymouth Rock? (A decision that I think was made over 25 years ago.)

That said, CET appears solid on these factors (expenses, turnover, and track record) in comparison to many equity CEFs, and the discount makes the overall package more interesting. Thanks for the article.

Why Central Securities Corporation Looks Attractive

Where did you see the $3265 valuation on Plymouth Rock? Is there more detail on how that figure was arrived at?

Morningstar CEF Ratings: Worse Than Random

Dan, did you get the impression that Morningstar has a model for CEFs that is reasonably tailored to CEFs as opposed to OEFs/ETFs?

In particular, a good CEF rating system should, IMO, distinguish between market returns and NAV returns, and should take the premium or discount into account, among other considerations.

A Poor Man's CEF Portfolio That Performs

Joe, I don't think your Big 10 is particularly analogous to the S&P 500. The S&P 500 has a long history of live data. The history for your index is, if I understand correctly, largely or entirely backfilled. Moreover, the S&P 500 focuses on one area of investing (large cap companies actively traded in the US), but your Big 10 is all over the board on asset classes.

Re: Investing in something like this with $10K. What do you estimate the outperformance of your portfolio is, relative to a similar baseline portfolio (using index funds)? I estimate it to be most likely negative, but even if you are optimistic and think this portfolio will outperform a baseline portfolio by, say, 2% per year, how much time do you think an investor will need to spend to really understand all the nuances of CEF investing? Are the time investment and the brokerage costs going to be justified on a $10K portfolio for an average American?

Re: Buying discounts. It's true that NAVs may not always be accurate/up to date for the point in time they're supposed to be valid for. That's yet another element of CEFs that would-be investors should take into account (adding complexity and research time). But I think that issue is relatively minor for MOST CEFs. To the extent that some CEFs have laggy NAVs right now, they are probably more likely to be overstated than understated (because the market, despite the recent rally, is far below peak values). So where significant discrepancies exist, they are more likely, in my mind, to overstate discounts.

Buying a fund at a >55% premium is almost certainly a tremendously foolish decision, in my opinion. Perhaps, with tremendous research into the true merits of the portfolio or some proven Buffett-like track record for the manager, one could justify such a thing, but IMO, the likelihood that PHK would be a "buy" (for me) after such research is low.

Re: Expenses. I don't like 1.5% *OR* 1.8% for expense ratios. I may be convinced to buy a CEF with such high expense ratios, but it will take a compelling discount and/or other factors (for example, a smaller discount but a high likelihood of near-term open-ending) to get me to do so. If you are aware of compelling research indicating that funds with higher fees outperform those with lower fees, I suggest you share it.

Re: Management fees/FOF. FOF is, as far as I know, the ONLY CEF (of the hundreds out there) that invests primarily in other CEFs (though, IIUC, some others do it with a limited slice of their portfolio). I suggest that it is more likely your readers would have taken your original reference to a "1.5% average CEF management fee" to refer to the fees charged by the CEFs themselves.

Re: Leverage. Many CEFs, like many companies, are leveraged. But when a leveraged CEF invests in equities which are themselves leveraged, the leveraging effects are compounded. Moreover, many of the leveraged CEFs are bond CEFs. Taking a relatively safe asset class (bonds) and leveraging it ratchets up the risk/volatility in a way that novice investors may not expect.

Re: Portfolio focus - performance? Finally, you make the claim in your comment that the portfolio "was not meant to be a portfolio of best CEFs" and that it "wasn't constructed to be a superior performer". Yet the article title is "A Poor Man's CEF Portfolio That Performs" In the second paragraph of the article, you highlight the underperformance of various fund managers. You include a graph (with "Performance" in the label) showing comparison of your index with two others. You have a paragraph labeled "Portfolio Performance Vs CEF Index:". I can't read your mind and don't know your original motives for the portfolio or the article, but in reading the article, it certainly comes across to ME as quite performance oriented, and thus I think my original criticisms of the performance claims are worthwhile.

A Poor Man's CEF Portfolio That Performs

I've realized that my explanation of the ongoing component of CEF expenses (#3 in my list) is somewhat oversimplified.

CEFs do "charge" internally, to run the fund. The manner in which those charges are computed varies from fund to fund. If I understand correctly, most funds charge a management and or similar fee(s), based on a fixed percentage of the total or net assets in the fund, and then charge various actual expenses (legal, accounting, printing, or whatnot) on top of that. So a fund's ongoing expenses are not necessarily fixed over time (the actual expenses may vary, and if the fund shrinks in size, a given amount of fixed expenses constitutes a larger percentage). In normal times, I would think that last year's expenses are a good estimate of what this year's will be. After the shrinkage that a lot of funds have gone through, that may not hold up very well for the near term.

Also, a few funds (like ADX - Adams Express, which is in Eqcome's "Big 10") are internally managed. If I understand correctly, the fund managers work directly for the fund, so instead of deducting some percentage of the fund assets for management, the fund actually pays their salaries and benefits. In ADX's case, these expenses have in recent years been somewhat lower than typical for the more prevalent structure I outlined above.

Also, when looking at CEFs that use leverage, depending on the source you look at, the interest cost of that leverage (what the fund pays to borrow the money) sometimes get lumped in with other expenses. This is misleading, IMO, and in some cases may make CEFs look worse, from an expense standpoint, than more unleveraged alternatives.

OK, so that was perhaps a confusing description, and it's possible I didn't capture reality perfectly for some or all CEFs. Still, it's important to understand CEF expenses, because they are, as far as I've seen, generally much higher than that for low cost index funds and/or ETFs. If your portfolio has average annual expenses of 1.2%, and you could construct a similar portfolio of ETFs with expenses of 0.2%, then you want to see the CEFs make up that extra cost in some fashion.

In my opinion, higher cost CEFs *can* be worthwhile in certain circumstances, primarily when trading at a significant discount. But you need to understand what you're getting and what you're paying for it. Again, unless you're willing to accept sub-par performance, you shouldn't stumble into them without doing your homework, and the time you'll likely need to invest to do your homework is probably too much to justify with a very small portfolio.

A Poor Man's CEF Portfolio That Performs

CEF = Closed-End Fund

A Poor Man's CEF Portfolio That Performs

One more thing:

Comparing your constructed portfolio, which includes domestic and world equities and various kinds of bonds to a large cap US index (the S&P 500) is not apples-to-apples. It's not even apples-to-oranges. It's apples vs a fruit basket containing apples, oranges, plums, pears and other fruit.

If you want to make the case for CEFs as a particularly useful investing tool, you should compare CEFs to a non-CEF alternative with a similar asset class make-up. Either limit your CEF choices to domestic, large cap equity and stick with the S&P 500 as a benchmark, or find a better benchmark that more closely resembles, at the underlying level, your portfolio/index.ns

A Poor Man's CEF Portfolio That Performs

Hoo boy...

Where to start?

1) An investor with $10,000 to invest doesn't need the complexity of something like this. The (likely potential) incremental returns improvements from this on a $10K portfolio are small, relative to incremental costs and complexity it adds versus a plan based on 2-4 low cost index funds.

2) One of the major attractions of CEFs is the ability to buy them at a significant discount. Of your 10 funds, only 3 are at a 10%+ discount. You've even got a fund trading at a 55.72% premium in there! In my opinion, it is not smart to pay $830 (100 shares worth) for roughly $513 worth of underlying net assets.

3) Your chart includes the distribution yield, which, while somewhat useful, may very well confuse novice investors unfamiliar with CEFs (which often distribute more than they 'earn'). Your chart does NOT include each fund's expense ratio, which is VERY important.

4) Your cost comparison of the commissions of buying these funds implies that by paying some commissions up front, the investor is saving money in the long run, by avoiding "1.5% average CEF management fees". Your description is sloppy and may mislead novice investors. Perhaps you are referring to the AUM (Assets Under Management) fees that some financial advisors charge, ON TOP of fees in underlying investments. In any case, CEFs, like ETFs and mutual funds, have expense ratios that are built in. Investors don't see a line item charge on their brokerage statement for these, but they pay them all the same (they are, if I understand correctly, deducted from the assets of the funds, and effectively lower the NAV and/or distributions of the funds). Note that the expense ratios for CEFs are generally HIGHER than those for low cost, broad-based index funds or ETFs from Vanguard and similar companies.

So a small investor has to pay:

1) Commissions
2) Spreads (an implicit cost - roughly half the difference between the bid and ask price for a CEF).
3) Expense ratios

The first two are generally paid once when you buy and once when you sell. The last is an ongoing cost.

Yes, they avoid a fee to an advisor, if they don't use one. But an investor who is managing their own portfolio (and thus somewhat likely to read this article and perhaps follow the advice), is probably not using an investment advisor charging a wrap fee anyways, and may be confused by your language.

5) In an article seemingly aimed at less knowledgeable investors, you should mention that many CEFs, including some on your list, are leveraged. i.e. They borrow money in various ways to invest more in their target strategy. In good times, that can boost returns, but in bad times (such as we've recently experienced) that can magnify losses. Many leveraged CEFs are significantly riskier than similar non-CEF options.

6) Is this the first publication of your "Eqcome CEF Big 10 Portfolio"? If so, you should probably add a cautionary note for the promising-looking comparison chart. It is relatively easy to create an index or portfolio of investments that beat a benchmark like the S&P 500 over the last 5 years. Hindsight is 20/20. I shoulda/coulda bought Google back in the day. Indexes are far more reliable gauges of the value of a particular strategy or asset class going FORWARD from the time they are first constructed and published. This doesn't mean that it's wrong to show the backtest results for a newly constructed portfolio/index, but rather, you should disclose the date at which it first went 'live', and, particularly for an article aimed at novices, highlight the issues with such backtests.

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OK, so that was a lot of criticism of a relatively short article. Still, I think investors who are interested in owning CEFs should have a reasonable understanding of the costs and risks.

All this criticism does not mean that CEFs are necessarily a bad investment. In fact, much of my portfolio is currently in various CEFs. But would-be CEF investors should educate themselves. Understand the costs, the risks, the nature of CEF distributions (and the differences relative to more conventional dividend payments from other asset classes). Understand the nature of CEF premiums and discounts. Realistically, it will take many hours of reading (in my opinion), from a variety of different sources, to really understand CEFs. For a $10K portfolio, it strikes me as unlikely that the incremental benefits of informed CEF investing (relative to other good alternatives) will be large enough to justify the time and commission investment.

In particular, be able to solidly answer the question "Why CEFs?". If you don't know why, or if, they are superior for you than other investments, then you probably shouldn't be investing in them.

Disclosure - I currently own many CEFs, but not (at the moment), any of the currently listed "Big 10".