Desperately Seeking Returns In Asia-Focused Closed-End Funds

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Includes: APB, CAF, CHN, FAX, GCH, IAE, JFC, KEF, TDF, TTF, TWN
by: Thomas Hughes

Summary

In light of recent developments within the CEF sector and Asia focused CEFs in particular I am rethinking my position in APB.

Despite recent gains in NAV and managements quest to address the discount APB is on a path that may lead to liquidation.

With this in mind I've begun looking for my next move.

Developments within the CEF world, and those regarding Asia-focused CEFs in particular, have me rethinking my position on the Asia-Pacific Fund (APB). The sector seems to shrinking as funds are liquidated and consolidated, and APB is not immune to the ailment. I recently covered a presentation given by City of London Investment Management Company where they outlined many of the issues facing emerging market closed end funds today.

Notable closures include JPMorgan's China Region fund (JFC), the Korea Equity Fund (KEF) and the Thai Fund (TTF) all of which have suffered from persistent deep discount to NAV, erosion of capital and weak income (to shareholders).

The Asia-Pacific Fund itself is in the process of addressing persistent deep discount to NAV in an effort to bolster shareholder value. The board was recently empowered to pursue such avenues that might present themselves, including but limited to merger or liquidation.

(Shareholders) passed the advisory, non-binding proposal to approve the steps necessary to narrow materially or eliminate the Fund’s discount to net asset value, including through a merger or liquidation. The Fund’s Board of Directors will consider actions consistent with the results of the advisory vote at its next meeting.

To date I am happy with my position. Income remains low but the fund has seen notable increases in both NAV and share price over the past year. That being said, I want to be prepared for whatever may come, including the possibility of liquidation. When looking for my next target I want to remain within the China region if possible and the greater Asia Pacific region if not. I would also like to improve distribution yield. Last year's distribution from APB was about 1%.

  • The Asia-Pacific region could include Australia, India, Indonesia, Malaysia, Singapore and many others as well as China. The smaller China region may include Taiwan, Korea, Hong Kong and others with direct and significant ties to China.

I could move into Asian oriented ETFs but choose to focus on CEFs for value and income. CEFs trade at a discount that can be leveraged to enhance gains and dividends are typically much higher than what I find among ETFs. I also use discount as a means of assessing market sentiment; deeper than average, long term and/or historic low discounts can often indicate a market that is oversold and undervalued. To date this approach has been working and I wish to pursue it.

The Search Is On!

Of course, the search is not quite as easy as it sounds. Many funds are facing similar dire straits as APB and not in the running. Take for instance the Aberdeen Greater China Fund (NYSE:GCH). It is an equities focused fund investing at least 80% of portfolio in China securities with some exposure to the greater China region. It pays a small dividend comparable to APB's recent distributions but alas, may be rolled into a new fund proposed by Aberdeen. Aberdeen's is looking to merge 7 funds focused on emerging funds into one uber-fund. While attractive, this new fund is yet to launch and will have a broad global focus as opposed to the narrow China focus I am looking for.

Aberdeen's Asia-Pacific Income Fund (FAX) is not part of the proposed mega-merger but also not in the running for a number of reasons. First, the discount to NAV is smaller than the long running average which cuts it out from the value perspective. Second, it is invested in a much wider version of the "Asia-Pacific" region than I am looking for, as it includes Australia and India, both of which dominate the top ten holdings list. Add to this the fact it is a bond fund and it just isn't what I'm looking for.

Getting Warmer

The Taiwan Fund (TWN) caught my eye because it maintains a discount management plan which results in regular monthly share repurchases. Over the past 18 months this plan has helped to reduce the float and drive prices to a long term high. That being said, there is one factor that immediately disqualifies it from my search, it hasn't paid a dividend in several years and gives no indication of that changing. The DMP is interesting but I don't think its enough for me at this time.

The Dragon Fund (TDF) has a cool name and could be in the running if not for two things; the discount to NAV and the distribution. The fund is trading at a discount near -12%, in line with long running averages and indicative of a fund fairly valued by the market. The distribution is nice, this year's amounted to roughly 8.5% at today's prices, but is paid annually and already distributed so it would be another year before any income is seen. Other than that it would be a nice fit and is an attractive fund. It invests roughly 75% of its portfolio in China, Hong Kong and Taiwan shares with the remaining 25% invested in the Cayman Islands. The Cayman Islands are of course a haven for Chinese owned companies that wish to register outside of China in order to business outside of China.

Some Possibilities

The Voya Asia Pacific High Dividend Income Fund (IAE) also caught my eye. It pays a nice dividend and on a regular monthly basis and so is able to deliver income quicker than some others. At current share prices, distribution return is about 8% and attractive. The fund is focused on equity and capital appreciation but uses an aggressive option writing strategy to enhance earnings. This is a small concern but not too alarming, as I am not opposed to a little option writing myself. The prospectus allows for call writing on up to 50% of portfolio value which results in a relatively high turnover rate but also helps drive returns. The fund is trading at a deeper than average discount so does at least meet my basic criteria of income and value. The catch is that it is invests in the greater Asia Pacific region including Australia, India, New Zealand and also the UK (about 1.25%) for some reason. Another negative is that a lot of the past years distributions are return of capital.

The China Fund Inc, (CHN) is a possibility but with some caveats as well. The fund has seen substantial increases in NAV of the past year, in tandem with China's market rally, but most of the gains are unrealized while NII has fallen. Along with that there is a push from within the shareholder base to change management companies that leads me to think there could be trouble ahead. Granted, the vote to switch did not meet regulatory requirements but it was overwhelmingly in favor of change. Also, the yield is only about 1%, so not all that attractive in the end.

Morgan Stanley's China A Shares Fund (CAF) is a definite possibility. The fund meets a number of my criteria and would fit well into my plan. It is an equity fund with focus on mainland China A shares and in that sense a pure play on China. In terms of NAV it is trading a deeper discount than the typical fund and its own long term average, near -15%, which leaves a bit of room on the table from the value perspective. Along with this is a regular dividend that paid roughly 3.5% last year and is well above what we can expect to see from APB. A quick look at the past two years' distribution breakdown shows no return of capital; the downside is that it is paid annually.

What To Do?

I think it easy to say this will be a difficult decision in the least. There are a number of funds still in existence that may work but most are disqualified for not fitting my need for income, my desire for value and my focus on the greater China portion of the larger Asia Pacific region. Even the funds that most closely match my needs are failing in some form or another. The Voya Asia Pacific High Dividend Income Fund is too broadly focused; the China Fund has internal issues to deal with along with a lower yield; the Morgan Stanley China A Shares fund is too narrowly focused and pays on an annual basis and with irregularity. What to do now? Dig deeper into my top three picks and narrow it down to a final decision.

Disclosure: I am/we are long APB.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I do not plan on buying any funds listed in the next 72 hours but I do plan on buying one in the not too distant future. I will be looking deeply into my 3 top picks and coming back with my decision before the end of the month.