Single-Country Fund Prices Defy Underlying Logic
When is it smart to overpay for something? Never, of course. Yet look what people are doing with investment funds that specialize in foreign stocks.
The Indonesia Fund, which (surprise) invests mostly in Indonesian stocks, has rocketed $4.625 a share since Thursday and closed at $22.125 Tuesday on the New York Stock Exchange.
But the actual market value of the stocks in the fund, as priced on the Jakarta Stock Exchange at the end of last week, works out to about $13.50 a share. That means someone who shells out $22.125 a share for the fund is paying 64% more than the net asset value (NAV) of the fund’s investments.
Likewise, the India Growth Fund’s share price on the NYSE, now $29.875, is 54% ahead of the fund’s NAV per share of about $19.30. For the Korea Fund, the current premium is about 48%.
These investment funds are known as “closed-end” funds, and they differ from regular mutual funds in that they have a fixed number of shares outstanding, which trade on a stock exchange. A regular, “open-ended” mutual fund, in contrast, is constantly issuing new shares or buying back existing ones (and thus taking in or giving out money), as investors buy and sell.
For an open-ended fund, its share price always reflects the current value of the underlying assets. For a closed-end fund, share price and underlying value may have no relationship at all: Depending on investor demand--and the emotion of the market--investors may price the shares of these funds far above or far below the assets’ actual value at any given moment.
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What has sparked the closed-end funds’ huge share gains in recent days is a year-end rush by investors who appear desperate to own anything international. Foreign markets, especially Third World ones, have been soaring since midyear as global interest rates have come down and as the world economy’s prospects for ’94 have improved. Now people who delayed getting on the bandwagon are grabbing anything they can.
In part, the closed-end funds’ shares are merely following the latest surge in overseas markets. But the funds’ prices are rising far faster than the markets. On Tuesday, for example, Bangkok’s chief stock market index shot up 2.8% to a record high. The Thai Capital fund, meanwhile, leaped $1.125, or 5.2%, to $22.875 on the NYSE--after an 8.8% surge Monday.
Thomas J. Herzfeld, a Miami-based money manager who has specialized in closed-end fund investing since the 1960s, has a simple rule about paying a premium over a fund’s NAV: Don’t.
The way to make money in this group is to wait until a fund’s share price is selling at a discount to the NAV, he says. In other words, you want to pay 90 cents for $1 worth of assets, instead of $1.50.
Discounts were common a year ago in many then-ignored single-country funds, Herzfeld says, so that’s when he was loading up on them. Now the $30 million or so that he uses to trade in the funds is 90% in cash, he says.
“I’m not even bearish on these emerging markets,” Herzfeld says. He thinks many of them could run up further in 1994. “But I’m just not going to pay the premiums on these funds. They’re in never-never land.”
Herzfeld believes the stampede into single-country funds over the past week partly reflects the fact that the funds are an easy solution for impatient investors, individual and institutional: If you’ve just got to “own” Korean stocks now, the Korea Fund takes little guesswork.
And some Wall Streeters defend the premiums on closed-end funds by arguing that, especially for Third World markets, there are few options other than these funds. Many smaller nations ban or limit direct investment by non-fund outsiders.
But Herzfeld says it’s plain silly to chase these funds when they are at premiums. Wait to buy, he says, when nobody else wants them--on bad news like coups, riots, earthquakes, economic turmoil or other all-too-frequent national disasters.
(It’s also probably true that many investors would be better off in the long run in diversified open-ended foreign funds than in highly volatile, high-risk, one-country funds.)
Herzfeld likens the current rage for Asian and Latin American funds to the wild bidding for European funds in late 1989 and early 1990, after the Berlin Wall fell.
Shares of the Germany Fund, for example, sold for a 58% premium to NAV at the end of 1989. By the end of 1990, the fund’s price had plunged to a 1% discount to NAV. Investors who paid the peak price of $25.125 a share for the fund in ’90 are still a long way from even: The price is $12.375 now.
