Finding profit opportunities in closed-end funds

 Kevin B. Murray, The Daily Record Newswire

Investors seeking to purchase securities that are currently undervalued should take a close look at closed-end funds, many of which are currently selling at deep discounts to their net asset value.

For instance, one closed-end total return fund is selling at about a 20 percent discount to its net asset value. This fund’s holdings are comprised of a number of securities that you can either purchase directly by paying one dollar for one dollar’s worth of their value or buy them in a closed-end fund and currently pay eighty cents for a dollar’s worth of these securities.

The fund’s assets are composed of Berkshire Hathaway (48.75 percent of its assets) with another 33 percent of the fund made up of Yum Brands, Wal-Mart and JPMorgan Chase.

Closed-end funds were the original design for mutual funds. Like the currently better-known open-end funds, they offer an investor a pool of actively managed securities. Unlike open-end funds, CEFs offer a fixed number of shares (sold at an initial public offering), trade on an exchange (New York or American usually), and can have their market price diverge sharply from their net asset value.

A fund’s net asset value per share is arrived at by subtracting the fund’s liabilities from their assets and dividing by the number of outstanding shares. The fund’s assets are the securities held multiplied by their market value. Open-end funds sell at their NAV, while CEFs can sell above their NAV (at a premium), or below their NAV (at a discount).

Currently the majority of CEFs are selling at discounts to their NAV, many at discounts above 10 percent. Purchasing a CEF selling at a 10 percent discount, you are paying 90 cents for securities that if liquidated would currently be worth $1.

While many CEFs selling at discounts are true bargains, an investor must look at what securities are in the fund, look at its historical discount, see if the fund uses leverage and if so how much, see what the fund’s payout history is, and insure the fund’s objectives line up with your goals and risk preference. A large discount by itself does not make a CEF a wise investment for any individual investor.

Like open-end funds there are CEFs that specialize in various types of securities. There are CEFs that specialize in various types of fixed income (corporate, treasury and municipal) with differing maturity structures and credit quality. There are domestic and international equity CEFs, with some specializing in growth, others in value, some specializing in small-, mid- or large-cap, as well as in individual sectors or, in the case of international funds, in different countries or regions.

CEFs (particularly those purchased at a discount) can enhance the return of a properly balanced portfolio and provide generous distributions for income investors. With many CEFs currently selling at deep discounts to their NAV, a long term investor should look closely at purchasing selected CEFs for their portfolio. Investment management firms that have a history and track record of dealing with CEFs can be very helpful in meeting your investment goals and objectives.

Those wishing to learn more about CEFs should contact their investment advisor or contact a firm that has developed knowledge and experience in trading CEFs.

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Kevin B. Murray is a vice president at Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, nonprofits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.

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