Investment Insights

Jeff Benjamin

Quirky world of closed-end funds offers opportunities for investors

Flows into equity funds, reinstatement of some distributions are enticing

Apr 25, 2010 @ 12:01 am

By Jeff Benjamin

Awave of momentum is building in parts of the closed-end-fund market, driven by a steadily increasing appetite for equities and a return by some funds to the practice of making distribution payments.

Both trends will affect the share prices of select closed-end funds in relation to their net asset values.

“We're just now starting to see net inflows into equity mutual funds, and we're seeing a narrowing of the discounts of equity closed-end funds,” said Patrick Galley, chief investment officer of RiverNorth Capital Management LLC.

The growing appetite for risk through equity investments translates to the closed-end-fund arena, where fundamentals of supply and demand drive share prices in relation to NAV, said Mr. Galley, who manages the $305 million RiverNorth Core Opportunity Fund (RNCOX).

Unlike open-end mutual funds, which issue shares based on investor demand, closed-end funds issue a fixed number of shares through an initial public offering that then trade on exchanges. As a result, closed-end fund share prices are determined by market demand. While they theoretically should trade at NAV, closed-end fund shares typically trade at either a discount or a premium, a phenomenon that neither academics nor market participants can explain.

Closed-end funds in general have rallied with the rest of the market over the past year, and as more money flows into equities, the discounts on many funds will continue to narrow or even turn into premiums.

“We think a lot of people who missed the market to this point are now being forced in,” said Scott Miller, chief investment officer at Blue Bell Private Wealth Management LLC.

The firm, which has $270 million under management, invests in closed-end funds as part of its overall strategy.

“The money is flowing in, and this [discount narrowing] is already happening, but there are still some values out there,” Mr. Miller said.

Three examples of funds that still trade at attractive discounts are Adams Express (ADX), trading at a 16% discount to NAV, General American Investors (GAM), at a 15% discount, and Royce Value Trust (RVT), at a 14% discount.

The share price of Adams Express, which is managed by The Adams Express Co., gained 8.5% this year through last Wednesday, which compares with an 8.2% gain by the S&P 500.

The General American fund, which is managed by General American Investors Co. Inc., gained 8.9% during the same period, while the Royce fund, managed by Royce & Associates LLC, gained 17.7%.

The General American and Royce funds employ the use of leverage, which increases the level of risk.


Part of the reason that some closed-end funds are still trading at deep discounts is that managed payouts by many fund managers haven't yet been reinstated to levels in place prior to the stock market downturn.

The Royce fund, for example, suspended its policy of distributing the equivalent of 9% of NAV last May.

The fund distributions, which are attractive to income investors, are similar to dividend payouts in that they are paid quarterly.

However, unlike the corporate policy of paying stock dividends from earnings, some closed-end funds will increase the amount of their distribution by supplementing dividends of the underlying stocks with assets from the portfolio. As a result, in many instances, the managed distribution is largely a return of investor capital.

Recently, the distribution tide seems to be turning.

“We've started seeing more funds reintroduce distributions,” said Cecilia Gondor, executive vice president at Thomas J. Herzfeld Advisors Inc., which manages $100 million in closed-end funds.

Last year, fund managers faced the dilemma of either maintaining payout programs designed to keep discounts narrow or suspend programs and face potential pressure on their share prices but retain the net assets, Ms. Gondor said.

“Several funds chose the latter and suspended their payouts, [while] others reduced payments by substantial margins,” she said. “Less than a year later, with a strong rebound in the markets, the funds are beginning to re-evaluate their situations, and some are opting to reinstate their distribution policies.”

The reason for the change of heart, Ms. Gondor said, is partly due to a widening disparity between discounts on funds with little or no payout, compared with premiums on some funds with bigger payouts.

Consider Gabelli Global Multimedia (GGT), which suspended a 5% payout in February 2009 and introduced a 10% payout last month. The Gabelli fund is trading at a 9.4% discount to NAV, which compares with an average of about 2% for all closed-end funds.

As is the case with many management decisions on closed-end funds, the Gabelli fund, managed by Gabelli Funds LLC, was goaded into its move by activist shareholders.

Another example of management responding to investor appetite for payouts took place at H&Q Healthcare Investors (HQH), managed by Hambrecht & Quist Capital Management LLC.

The fund, which is trading at a 17% discount to NAV, suspended an 8% payout last June and reinstated it April 5.

“We're starting to see this happen more often, because the managers know that closed-end fund investors tend to be very income-oriented,” Ms. Gondor said.

Questions, observations, stock tips? E-mail Jeff Benjamin at


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