Closed-end funds are trading at discounts not seen in more than a decade, giving savvy investors plenty of opportunity to snap up a portfolio of securities for less than what those investments are actually worth.
Closed-end funds are mutual funds that trade on an exchange like a stock. Unlike the stock of index-based exchange traded funds, shares of closed-end funds are usually sold at prices that represent a premium or a discount to the value of their underlying assets.
At the end of September, the median discount to net asset value at which closed-end funds traded widened to 16.06%. In contrast, over the past two years, shares typically have sold for 2% to 8% below the funds' net asset value, according to Lipper Inc. of New York.
The deep discount reflects investor anxiety about what's going on in the stock market and the broader economy. That anxiety, which pushed the Dow Jones Industrial Average well below the 10,000 barrier last week, has many investors running from everything except U.S. Treasuries.
While today's discounts are bad news for investors that bought into the funds, they're good news for investors looking for a bargain.
"This could turn out to be the biggest buying opportunity in decades," said Cecilia L. Gondor, executive vice president of Thomas J. Herzfeld Advisors Inc., a closed-end-fund specialist in Miami.
In addition to being a registered investment adviser with about $100 million under management, the firm runs The Herzfeld Caribbean Basin Fund Inc. (CUBA), a closed-end fund.
Indeed, opportunities abound for closed-end-fund investors, said John Cole Scott, executive vice president of Closed-End Fund Advisors Inc., a Richmond, Va.-based firm with about $80 million in assets.
The firm is looking at a number of closed-end funds trading at a wide discount. They include The European Equity Fund Inc. (EEA), from DWS Investments, a unit of Deutsche Asset Management Inc. of New York, which was trading at a discount of 23.38% as of Sept. 8.
Closed-End Fund Advisors is also considering the Nuveen Global Government Enhanced Income Fund (JGG), from Nuveen Investments Inc. of Chicago, which was trading at a discount of 16.84%, and the Alpine Global Premier Properties Fund (AWP), from Alpine Woods Capital Investors Inc. of Purchase, N.Y., which was trading at a discount of 25.38%.
Still, bargain-hunting investors should proceed with caution.
Nobody wants to jump into a fund with a wide discount only to realize that the fund's NAV is eroding, thereby wiping out any advantage that that discount might have afforded them, Ms. Gondor said.
It's something to consider given that closed-end funds' NAV dropped last month.
Indeed, the average equity closed-end fund dropped 13.22% on an NAV basis, and the average fixed-income fund was down 8.31%, according to Lipper.
"You will need to pick where you invest very carefully to avoid future pitfalls and increase you upside gain," Mr. Scott said.
That said, closed-end funds that invest in municipal bonds are looking good right now, Mariana Bush, a Washington-based analyst of closed-end and exchange traded funds with Wachovia Securities LLC of St. Louis, wrote in a Sept. 25 report on the closed-end fund market.
"While we recognize that volatility is likely to persist for now, we think municipal closed-end funds are attractive because we expect generally stable [income] distributions, their valuations are historically inexpensive ... and their underlying asset class is appealing," she wrote.
The average discount of all municipal closed-end funds was about 8%, Ms. Bush wrote. The 10-year average among muni closed-end funds was just 3.7%.
Closed-end-fund managers said they are seeing increased interest in their funds. More investors are calling with questions, said Tom Dinsmore, president of Dinsmore Capital Management Co. of Morristown, N.J., adviser to the Bancroft Fund Ltd. (BCV) and Ellsworth Fund Ltd. (ECF).
"We're seeing higher average daily volumes in some of our unleveraged funds," said Anne Kritzmire, a managing director and head of the closed-end-fund business at Nuveen.
By contrast to leveraged equity funds, unleveraged funds do not use leverage to magnify changes in NAV. Similarly, such funds refrain from using leverage to boost yields.
Many closed-end-bond funds are suffering because the cost of leverage has risen as a result of unresolved issues stemming from auctions of preferred securities used to achieve leverage, which began to fail in February.
Two closed-end-bond funds from Putnam Investments of Boston — the Putnam Managed Municipal Fund (PMM) and the Putnam Municipal Opportunities Trust (TSO) — announced Sept. 12 that they plan to merge with similar Putnam open-end funds.
Three closed-end-fund advisers in particular — BlackRock Inc. of New York, Eaton Vance Corp. of Boston and Nuveen — developed plans to create ARPS structured in such a way as to make them available to money market funds.
The hope was that money market funds would buy the securities — intended to replace established ARPS — providing liquidity to the market.
After some initial success, however, money funds ran into their own problems resulting in outflows.
As a result, demand for the restructured ARPS dried up, Ms. Gondor said.
E-mail David Hoffman at email@example.com.