Closed-End Funds At Discount Prices

3/19/2012


Like smart shoppers, smart investors look for discounts.

Unlike traditional mutual funds, closed-end stock funds may trade at a discount to net asset value (NAV), the underlying value of the assets in their portfolios. In other words, closed-end fund investors can sometimes buy a basket of stocks cheaper than they could if the stocks were cobbled together in a conventional open-end mutual fund. Supply and demand determines the market price of a closed-end fund, and that will often differ from the NAV.

While some closed-end stock funds trade at a premium, most carry discounts. According to Lipper and based on 219 stock funds, 174 (79%) traded at a discount at the end of February. Several factors can impact the spread between market price and NAV, including relative performance, cash distributed to shareholders, expenses, trading liquidity, and potential tax liabilities from unrealized gains.

While buying closed-end funds at a discount may sound like a sure thing, it's not. If a discount narrows, your returns will outstrip returns calculated using NAV. But sometimes discounts widen and market prices decline.

To put a fund's discount in perspective, compare it to its historical average. The average closed-end equity fund trades roughly 9.8% below its NAV, versus a 12.6% discount at the start of the year.

SELECT CLOSED-END STOCK FUNDS
Closed-end funds can trade at a discount to the value of the assets in their portfolios. Note that some funds deliver high income because they use leverage, or borrowed money, to buy securities. The leverage ratio represents leverage (loans, etc.) as a percentage of the sum of leverage and net assets.
-------- Discount To NAV --------
Fund (Price; Ticker)
Distri-
bution
Ratio
(%)
Recent
(%)
12-Month
Average
(%)
5-Year
Average
(%)
Leverage
Ratio
(%)
Expense
Ratio
(%)
Adams Express
($11; ADX)
6.1
(14.9)
(14.6)
(14.7)
1
0.54
AGIC Equity & Conv.
($18; NIE)
6.2
(11.0)
(10.3)
(9.3)
0
1.09
Central Securities
($22; CET)
5.4
(16.8)
(16.3)
(16.6)
0
0.68
Cohen & Steers Oppor.
($13; FOF)
7.8
(7.2)
(8.2)
(5.8)
0
0.96
NASDAQ Premium Inc.
($15; QQQX)
7.9
(4.4)
(4.3)
(5.3)
0
1.04
Royce Focus ($7; FUND)
6.0
(12.3)
(12.7)
(6.6)
14
1.34
Royce Value ($14; RVT)
5.4
(12.7)
(13.6)
(11.0)
18
0.99
Source Capital
($53; SOR)
5.3
(12.7)
(10.9)
(10.2)
9
0.95
Tri-Continental ($16; TY)
2.0
(14.2)
(14.2)
(12.4)
10
0.59
Zweig Total Return
($3; ZTR)
11.4
(10.9)
(12.1)
(7.7)
0
0.97

Listed above are 10 closed-end stock funds trading at sizable discounts to NAV. All 10 have reasonable expense ratios, attractive distributions, and solid track records. Before investing, note the following:

• Fund distributions may include interest income, dividends, realized capital gains, and return of capital. Most closed-end stock funds make payments once per year in November or December. Some funds pay a predetermined amount, even if they lack the dividends or interest income to satisfy that obligation. In some cases, those funds may make up the difference by returning the capital investors paid in.

• Distribution rates are typically presented as a percentage of NAV. For shares bought at a discount, the actual distribution rate will be higher. Conversely, for shares bought at a premium, the rate will be lower.

• Many funds use leverage, or borrowed money, to juice returns and boost distributions. While not necessarily a bad thing, leverage can increase a fund's share-price volatility and expenses.

OUR RECOMMENDED MUTUAL FUNDS
Through March 13, our recommended Growth Portfolio has gained 11.4% so far this year, versus a 11.3% gain for its benchmark portfolio. The Conservative Portfolio is up 10.1%, versus 8.4% for its benchmark.
-- Year-To-Date --
--- % Of Portfolio ---
 
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
Buffalo Growth ($28; BUFGX)
12.3
E
12
12
81
Dreyfus Midcap Index ($30; PESPX)
13.9
B
0
0
75
Dreyfus Small Cap Stock Index
($22; DISSX)
11.8
D
0
0
80
Homestead Small Company
($26; HSCSX)
13.2
B
7
8
100
Manning & Napier International
($8; EXITX)
10.0
D
7
7
67
T. Rowe Price New Horizons
($36; PRNHX)
15.8
B
10
10
98
Vanguard 500 Index ($129; VFINX)
11.5
C
6
7
79
Vanguard Dividend Growth
($17; VDIGX)
7.2
E
12
12
91
Vanguard Emerg. Mkts. Stock Indx.
($28; VEIEX)
17.3
C
0
4
91
Vanguard GNMA ($11; VFIIX)
0.2
B
5
4
94
Vanguard Inter.-Term Tax-Exempt
($14; VWITX)
1.6
B
0
0
67
Vanguard Selected Value ($21; VASVX)
10.3
E
5
6
90
Vanguard Short-Term Invest.-Grade
($11; VFSTX)
1.5
B
0
0
91
Vanguard Total Bond Mkt. Index
($11; VBMFX)
0.3
E
9
0
52
Vanguard Total Int'l Stock Index
($15; VGTSX)
13.0
B
5
4
89
Vanguard Wellesley Income
($24; VWINX)
3.5
E
0
0
100
Vanguard Wellington ($34; VWELX)
7.2
D
6
9
90
Wasatch International Growth
($21; WAIGX)
16.3
A
5
5
100
Wells Fargo Advantage Discovery
($27; STDIX)
17.5
A
6
7
94
Wells Fargo Advantage High Income
($8; STHYX)
4.9
D
5
5
43
* Year-to-date ranks through March 13 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%;
E = bottom 20%. Fund ratings are percentile ranks based on our fund-rating system.

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