Closed-End Funds Are a Bargain During Slump

There’s something inherently gratifying about getting a bargain, whether it’s a knickknack for the house or an investment. Among mutual funds, the red-tag sales are being held in the closed-end department.

Even in normal times, most closed-end funds sell below their “net asset value,” or NAV--the per-share worth of the securities held. At the moment, with the stock and bond markets in a slump, there are more potential bargains than usual. “We’re seeing some of the best buying opportunities in years,” declares Thomas J. Herzfeld, head of Thomas J. Herzfeld Advisors, a closed-end money management and research firm based in Miami.

Closed-end funds are diversified, professionally managed portfolios that invest in stocks, bonds and, occasionally, other assets. Unlike regular, open-end mutual funds, they don’t routinely sell new shares to investors at the current NAV (plus a load, if applicable), nor do they buy them back.

Instead, the number of shares in a closed-end fund stays more or less fixed and the prices of these shares fluctuate on the open market, like an individual stock or bond. This creates the possibility of a closed-end portfolio selling above or below its NAV--at a premium or discount, respectively.

Closed-end funds number more than 250, with most trading on the New York or American stock exchanges. When shopping, examine a fund’s dividend policy, management, expense ratio, performance and other factors. “But if you had to pick one variable . . . it would have to be the discount or premium,” Herzfeld says.

Barron’s tracks discounts and premiums weekly, as does the Wall Street Journal on Mondays (stock funds) and Wednesdays (bond funds). Prices are listed daily in the stock tables of The Times and other newspapers.

As noted, most closed-end portfolios tend to trade at discounts. This in itself doesn’t guarantee a profit, because the markdown could widen or the value of the underlying holdings could drop.

But if you buy a closed-end fund well below its NAV, you increase your chances for long-term success. “A wide discount provides some cushion,” says Douglas Dent, editor of Cappiello’s Closed-End Fund Digest, a newsletter based in Santa Barbara. Currently, closed-end bond and foreign stock funds appear to offer some of the better buys. Several fixed-income selections are selling at double-digit discounts, with yields in the 12% to 15% range, Dent says.

Portfolios with large concentrations of junk bonds have fared especially poorly and thus could offer good returns if the market stabilizes. “The pure junk bond funds are totally out of favor. Some are selling at discounts of 40% to 50%, and their yields are as high as 25%,” says Roger Wilson, president of Northwest Quadrant, a money management firm in Newport Beach. At such steep markdowns, several of these funds will probably prove to be good investments over the long haul, he says, even if some of their junk holdings default, which is probable.

More appealing in Wilson’s view are medium-quality portfolios that typically hold combinations of U.S. government bonds, foreign government bonds and junk. Some lately have traded at discounts as high as 20%, with yields of about 15%, he adds.

If interest rates decline, that would push up the prices of good-quality bonds, although junk issues could stay depressed, at least until the economy strengthens.

Money managers and researchers who follow closed-end funds believe that the market for these securities is relatively inefficient, which might explain why discounts sometimes widen so drastically. Individuals, not institutions, account for most of the buying and selling. As a result, many closed-end funds are less well-researched than, say, blue chip stocks or highly rated corporate bonds.

Observers blame Wall Street, at least in part, for the current wide discounts on equity and bond funds. Brokers earn more selling closed-end investments as new issues rather than in the after-market and thus tend to neglect the securities after they come out, Dent says. In fact, the price of a new closed-end portfolio will generally drop by the amount that goes to brokers as compensation. For this reason, it’s often wise to avoid the funds when they debut.

Many closed-end selections, including the foreign stock portfolios, are managed by U.S. firms that also run regular, open-end mutual funds, often with a similar investment slant. This entails some interesting implications.

For example, if you find a closed-end selection managed by a company you like, you can buy the firm’s expertise at a discount to what you might pay for a similar open-end fund.

In addition, you can avoid the sales fee that many fund groups charge. Alliance, American Capital, Colonial, Massachusetts Financial Services (MFS), John Nuveen, Putnam, Templeton and Van Kampen Merritt are among the many load companies that also manage closed-end portfolios.

Of course, you must still pay a broker’s commission when buying or selling a closed-end fund as you would on a stock transaction.

It’s important to emphasize that even if you buy a fund at a discount, you won’t necessarily make money. That discount can always widen, and the value of the underlying holdings can decline. Wilson expects to see lower prices--and potentially better buys--during the next several weeks as disheartened investors dump their closed-end funds to lock in tax losses before year-end.

On the other hand, some closed-end managers plan to convert their funds to open-end status, which would eliminate discounts. Sometimes the firm will voluntarily put the question up to a shareholder vote; in other cases a corporate raider may force the issue.

“Either managements on their own are taking what might be viewed as drastic measures to narrow the discounts, or shareholders are giving them a push,” says Herzfeld, who adds that the number of conversions has increased this year as discounts have widened.

FUNDS AT A DISCOUNT

Closed-end portfolios offer the diversification and professional management of mutual funds, yet they trade like stocks, with prices determined by investors in the open market. At the moment, scores of closed-end funds are trading at substantial discounts to their “net asset value,” or per-share worth of the underlying holdings. The following funds, all of which trade on the New York Stock Exchange, are among those favored by the advisers quoted in the accompanying column.

FOREIGN STOCK FUNDS

1990 Range of Recent Recent Discount (D) Name (NYSE Symbol) Price Discount or Premium (P) First Philippine (FPF) $7.250 26% 34%(P) to 29%(D) Latin America Investment (LAM) 9.625 28% 0%(D) to 28%(D) New Germany (GF) 11.125 17% 78%(P) to 28%(D) Scudder New Asia (SAF) 14.000 18% 2%(P) to 28%(D) Scudder New Europe (NEF) 9.250 17% 20%(P) to 25%(D)

BOND FUNDS

1990 Range of Recent Recent Discount (D) Name (NYSE Symbol) Price Discount or Premium (P) American Capital Bond (ACB) $15.375 17% 3%(D) to 18%(D) Global Government Plus (GOV) 6.750 17% 4%(D) to 20%(D) MFS Intermediate Income (MIN) 7.625 9% 3%(P) to 13%(D) Putnam Premier Income (PPT) 6.500 17% 0%(D) to 19%(D) Putnam Master Income (PMT) 6.625 17% 1%(D) to 19%(D)

Source: Range of discounts and premiums for 1990 provided by the Investor’s Guide to Closed-End Funds, Thomas J. Herzfeld Advisors.