With most investments, the idea is to buy low and sell high. Why not go a step further and buy a baked-in discount? Closed-end funds allow investors to do just that, if the timing is right.
Unlike traditional open-end funds, closed-ends issue a fixed number of shares that trade the same way as stocks. And just like stocks, the shares of closed-end funds are priced according to supply and demand in the marketplace. The difference between a fund's share price and its underlying net asset value (NAV) is called a "premium" or a "discount." In a discount scenario, investors don't pay full price for the underlying assets.
Discounts on closed-end funds are typically steepest late in the year, and 2007 was no exception. In November and December, investors scooped up closed-end funds at 10 percent and 11 percent discounts thanks to year-end tax-loss selling and volatility in the market. As of February 22, the median discount for closed-end funds was 7.4 percent, according to Lipper. "From a comparative point of view, that's still attractive," says Tom Roseen, a senior research analyst at Lipper. "If you can put money to work in this market, then you can purchase something for 5 percent less than it's worth. And if you're going for yield, even better." Since closed-ends pay income based on net asset value, discounted shares translate into a fatter yield.
In today's tumultuous market conditions, Morgan Stanley analyst Paul Mazzilli likes option-income funds, which sell call options (rights to buy stocks at a preset price.) "This caps some of your upside, but in volatile markets or down markets, these funds outperform and also have good current yields," Mazzilli says.
One of his favorites is Eaton Vance Tax-Managed Global Diversified Equity Income (ticker symbol EXG), which is trading at a 7.9 percent discount to NAV and yields 11.8 percent. He also likes Nuveen Global Value Opportunities (JGV), which is trading at a 2.1 percent discount to NAV and yields 8.8 percent. Among large-company-focused stock funds, Mazzilli favors two with low annual expenses and high insider ownership: Adams Express Company (ADX) and General American Investors (GAM). Both offer low yields, but Adams trades at a 13.3 percent discount and General American trades at an 11.3 percent discount.
As with any product, investors should scrutinize before they buy, says Anne Kritzmire, managing director of Nuveen Investments. "A lot of people only look at premiums and discounts, but investors should consider the asset class, the manager, and the record as well," she says. It's also worth putting that discount in perspective: You can check a fund's share price and NAV history at etfconnect.com.