Thinking Foreign? Closed-End May Be the Ticket
Global financial markets have come roaring back in recent weeks. That may have more investors thinking about easing back into the deep end of the pool--perhaps into an emerging-market stock mutual fund or other higher-risk market sector.
If you’re in the market for risky funds, consider “closed-end” portfolios. You have a chance to get many of them on sale.
Closed-end funds--unlike the open-end variety most investors are more familiar with--are mutual funds whose shares trade on the major exchanges, just like stocks.
This gives a closed-end fund two prices--and, some would argue, gives both the funds and their investors an advantage.
As with its open-end counterpart, a closed-end fund has a price that reflects the current value of its holdings, known as its net asset value, or NAV, per share.
But contrary to an open-end mutual fund, a closed-end fund has a second price--the price at which its shares are bought and sold on the public exchanges. This is its market price. And this is the price that determines how much a closed-end fund investor makes or loses on the investment.
If a fund’s market price is below its NAV per share, it is said to be trading at a discount to true value. If, for whatever reason, investors bid a fund’s market price above its NAV, then it is trading at a premium to its true value.
Notes Ronald Olin, president of Deep Discount Advisors, a money management firm in Asheville, N.C., that specializes in closed-end funds: “You can use the discount as a simple barometer of value. The bigger the discount, the better the value” in a closed-end fund.
The good news for investors is that many closed-end funds now trade at huge discounts to their NAVs.
Indeed, the typical closed-end emerging-markets stock fund is trading at a 16.1% discount to NAV, according to CDA/Wiesenberger, a fund researcher in Rockville, Md.
This means that you can literally buy $1 worth of emerging markets stocks in the typical portfolio for 84 cents.
Take Scudder New Asia. Its shares closed Monday at $9.25 apiece on the New York Stock Exchange. But as of Friday, the fund’s net asset value--the liquidation value of its holdings--was $10.69 a share, according to Bloomberg News.
That means Scudder New Asia shares were trading for 13.5% below what they were actually worth.
Sounds like a great deal. But if closed-end funds like New Asia are such screaming bargains, why isn’t everyone investing in them?
It’s a which-came-first, the-chicken-or-the-egg issue.
Over the years, investors have overwhelmingly favored open-end mutual funds, while demand for shares of closed-end portfolios has been modest. Without an influx of buyers, shares of many closed-end funds have remained at discounts for simple lack of interest.
But one could also argue that the reason closed-end fund demand has been so weak is that many closed-end fund shares seem to perpetually trade at discounts to NAV.
Nonetheless, analysts say closed-end funds are worth considering--especially now.
In addition to the big discounts to true value, the closed-end model itself is seen as having an advantage for portfolio managers and thus for long-term investors, especially when investing in risky, out-of-favor sectors.
Most stock fund managers tend to be fully invested--meaning they invest nearly every dollar plowed into the fund into the market. That leaves them with little cash. Should investors want out of an open-end fund, the manager would, in all likelihood, have to begin selling stocks to cash out investors.
This selling can hurt the fund’s performance--because the manager may have to sell stock winners in the process. Indeed, redemptions have been a major concern for open-end fund managers during the recent market slide.
Not so for closed-end funds. Once their capital is raised and invested, “There aren’t any withdrawals or redemptions” from closed-end funds, noted Gregg Wolper, closed-end funds editor for Morningstar Mutual Funds. “It’s a way to protect against a run on the fund.”
From a fund manager’s perspective, then, the closed-end structure creates a more stable environment for stock picking. That may be one reason the NAV of the typical closed-end emerging-markets fund fell 26.1% between Jan. 1 and Oct. 23, while the average open-end emerging-markets fund fell 31.9%, according to Lipper Analytical Services.
Where should an investor considering closed-end funds begin looking today?
There are closed-end funds investing in each of the main market sectors--U.S. stocks, U.S. bonds and foreign stocks and bonds.
One option for investors who are adjusting their open-end fund portfolios at year-end is to look for a closed-end fund in the same sector.
For example, if you are planning to sell an open-end fund to lock in losses that you can use to offset capital gains, consider taking some of the proceeds of those sales and investing in a closed-end fund that invests in similar securities.
To be sure, you may end up buying into a taxable capital gains distribution on any mutual fund, open-end or closed-end, that you buy in November or December (since most funds pay built-up gains to shareholders at this time of year). But that may be less of a concern if you’re getting a closed-end fund at a substantial discount to NAV.
Also, capital gains distributions may not be an issue for many battered emerging-market closed-end funds.
Indeed, analysts say investors would be best off using closed-end funds to invest in foreign stocks today, particularly in emerging markets.
Not only do foreign stock funds outnumber domestic ones in the closed-end universe--which encompasses only about 500 funds--many are trading at deeper discounts than their domestic peers.
Thomas J. Herzfeld, head of Thomas J. Herzfeld Advisors Inc. in Miami and a leading expert in closed-end funds, says closed-end investors should act like value hunters and seek out funds whose shares are trading at NAV discounts wider than their peers and their own historic average discounts.
Kristoph Rollenhagen, director of closed-end fund research at Prudential Securities in New York, agrees. But he believes investors ought to consider more than just a fund’s NAV discount.
Evaluate a closed-end fund as you would an open-end fund, he says--judging how well the fund manager has performed, as measured by the change in the NAV price over time. (This information is available from the fund itself or independent researchers like Morningstar. Current fund discounts are listed in Barron’s magazine weekly.)
The following are some closed-end stock funds that analysts are currently recommending:
* Dessauer Global Equity (ticker symbol: DGE). According to Lipper, the typical open-end world stock fund has lost about 6% (in total return) year to date. DGE, on the other hand, has risen a little less than 1%. Still, this world equity fund--which invests primarily in blue-chip names in North America, Western Europe, Asia and Japan--trades at a 9.8% discount to NAV, near the high end of its discount range in 1998.
* Invesco Global Health Sciences Fund (GHS). The same argument for health-care investing at home--the aging of the population and the continued demand for cost-effective medical treatments--is applicable abroad.
The fund currently invests in large U.S., British and Swiss health-care stocks, with more than 54% invested in pharmaceutical firms, the drivers of the current bull market in the sector. Over the last three years, the fund has delivered annualized returns of 29.2%. Yet, its shares still trade at a 7.5% discount to NAV.
* Emerging Markets Infrastructure (EMG). This global fund invests up to 60% of its assets in emerging markets. But it tends to focus on less volatile industries such as utilities, telecommunications, energy and construction.
Despite outperforming the benchmark Morgan Stanley Emerging Markets Free index by nearly 10 percentage points each year for the last three, the fund still trades at a deep 25% discount to its NAV.
* Morgan Stanley Emerging Markets (MSF). This fund is among the more diversified of its category, with the bulk of the portfolio in companies in 10 countries: Brazil, Mexico, Russia, Turkey, South Africa, India, Taiwan, Argentina, Israel and South Korea.
You could argue that that diversification didn’t prevent the fund’s NAV from falling 47.5% over the past 12 months, that drop is nevertheless roughly in line with the losses for the average open-end diversified emerging markets fund. And this fund’s shares now trade at a 19% discount to NAV.
* Europe Fund (EF). If you’re looking for more region-specific exposure, this fund is an interesting idea. Europe Fund has consistently beaten the Morgan Stanley index of European stocks over the last three years. Over the last 12 months, the fund has delivered a gain of 33.3%, at a time when the average open-end Europe stock fund was up only 11.7%, according to Morningstar. The fund is now trading at a 12% discount to its NAV.
* Latin American Equity Fund (LAQ). For more aggressive investors, analysts recommend a look at Latin America. Notes Morgan Stanley Dean Witter analyst Paul Mazzilli: “Latin America still offers some of the most attractive economic fundamentals in the emerging markets and appears well-positioned for long-term growth.”
Over the last four weeks, this fund--which invests about a third of its assets in Brazil, a fifth in Mexico, and 10% each in Argentina and Chile--is up nearly 13%. Yet it trades at a whopping 26.7% discount to its NAV.
* Latin America Investment Fund (LAM). This Latin American fund, managed by the same confirm as Latin American Equity, announced last week that it would buy back up to 15% of its shares. Analysts believe this will help narrow the fund’s 26% discount.
* Latin American Discovery Fund (LDF). Compared with LAQ and LAM, this Latin American fund is a bit more concentrated. It recently had 75% of its assets in Brazil and Mexico, and was over-weighted in the telecommunications sector. LDF has fallen 30.6% over the past 12 months. But according to Morningstar, the typical open-end Latin American stock fund has fallen more--32.3%--during this time.
Morgan Stanley’s Mazzilli, who rates this fund a “strong buy,” notes that LDF has beaten the Morgan Stanley Latin America Free index by more than 11 percentage points annually for the last three years. Currently, the fund’s shares trade at a 19.5% discount to NAV (at one point recently the fund had been trading at a premium).
* Analysts also recommend two single-country closed-end funds: The Mexico Fund (MXF), which is trading at a 26% discount; and India Fund (IFN), trading at a 24% discount.
Mazzilli especially likes IFN, in part because he expects corporate earnings in that country to grow 20% in 1999, in part because of government reforms.
A word of caution, though, when it comes to such single-country funds: Because they invest in companies in a single market, they are extremely risky, pros say. They note that these funds’ holdings could all fall in unison based on a single economic or political event. That’s why they recommend investors approach these as they would individual stocks--as a something that offers little diversification but that could boost your overall portfolio’s performance.
Times staff writer Paul J. Lim can be reached by e-mail at paul.lim@latimes.com.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Closed-End Funds on Sale?
Here is a sampling of closed-end mutual funds whose shares are priced at a discount to the true per-share value of the portfolio holdings, or net asset value per share. Shown are the funds’ latest discounts, their market price gains over the last four weeks and year-to-date returns.
*--*
Discount 4 wk. YTD Fund name Ticker to NAV tot. ret. tot. ret. Latin American Equity LAQ -26.7% 12.8% -43.8% Mexico MXF -25.8 15.4 -44.2 Latin America Investment LAM -25.7 14.5 -38.0 Emerging Markets Infrastructure EMG -25.2 15.6 -37.8 India IFN -23.6 5.3 -16.1 Latin American Discovery LDF -19.5 18.9 -38.3 Morgan Stanley Emerging Markets MSF -18.9 18.7 -25.5 Europe EF -12.2 9.6 9.2 Dessauer Global Equity DGE -9.8 11.7 0.6 Invesco Global Health Sciences GHS -7.5 10.6 25.5
*--*
Figures as of Friday. All shares trade on the New York Stock Exchange.
Source: Bloomberg News
