Bulls, bears debate value of gold investing
2009 a banner year for closed-end fund investors
By DIAN VUJOVICH
Special to the Palm Beach Daily News
November 21, 2009
Unless your broker was on top of things, odds are you probably missed the rally in closed-end fund performance this year. Over the past 12 months, funds on average saw their total returns up more than 45 percent — and some as much as 150 percent. As for the income many provided their shareholders, when compared to puny CD rates, let's just say it has been juicy.
Are investors likely to hit it big in these stocks and their returns in 2010?
That all depends.
Thomas Herzfeld has made a successful career of tracking and investing in closed-end funds for decades. Ask him about next year, and you'll learn that November and December are typically "buying season" for closed-end funds.
"That's because sometimes closed-end funds are undervalued and sometimes they get pricey," says Herzfeld, whose Miami firm bears his name. "When there are wide discounts in their Net Asset Value, it's a buying opportunity. And that usually comes up at the end of the year when investors tend to unload them for tax purposes."
That same sell-at-the-end-of-the-year strategy is true for many who invest in stocks in general but closed-end fund aren't like ordinary stocks, they are a kind of ordinary stock and mutual fund combo. As such, each fund represents a basket of securities that may be made up of any variety of stocks or bonds and investors need to be mindful of two things — the per-share price that a closed-end fund is trading at and the fund's Net Asset Value. Closed-end funds typically sell at a premium or a discount to their fund NAV.
Investing in a fund whose shares are selling at a premium to the fund's NAV isn't considered the best idea.
"It's always at least one strike against them," says Herzfeld. "Sometimes they start at a premium and, if you're collecting the yield, okay. But if anything goes wrong and the market starts to reverse or the fund has dividend cuts, all of a sudden a premium can invert to a discount and you lose a lot of money."
Savvy closed-end fund investors understand the benefits of finding fund shares with NAVs trading at deeply discounted prices (rather than those selling at a premium) and 2008 offered them a bonanza of buying opportunities. With the stock market in the tank, economic uncertainty and investors frightened about the future, discounts abounded and it truly was a closed-end fund picker's market. The same was true this spring.
According to the Closed-End Fund Association, the trade association for the industry, closed-end funds began this year with an average discount to their NAV of 11.15 percent. By the end of the third quarter '09, that spread had narrowed to 2.48 percent.
As for returns, of the 626 closed-end funds tracked by FundData, the average closed-end fund's total return was up more than 45 percent for the year through Sept. 30.
Municipal funds dominate the closed-end fund universe, and represent about 42 percent of all closed-end funds traded in the United States, according to Herzfeld. Their appeal is simple — tax-free income. And in a year when yields on anything haven't amounted to much, tax-free yields on closed-end municipal bonds have ranged from 4 percent to 7 percent.
"This is one of the best, if not the best (year) in terms of total performance for closed-end funds," says Brian Smith, a spokesman at the association.
But there is more to a closed-end fund's total return than, say, a stock's dividend or income from a bond. Total return can include capital gains and loses, dividend payouts, income from holdings, and even a return of capital. It's that return of capital part that can make a closed-end fund's stream of income look more bountiful than it really is.
"At our Web site (www.closed-endfunds.com), we report specifically the market return along with income-only yield and the distribution yield, or market yield," says Smith. He explains that an income-only yield reflects the true earnings of the fund and what's available for distribution. The market yield includes other components — one of them may be a return of one's own capital.
If there's one warning signal all closed-end fund investors ought not to overlook it is how wide or narrow the spread between the fund's income-only yield and its market yield is.
"If you've got a big market yield and a very low income-only yield, that's a red flag and means you may be getting back some of your own money and need to investigate (the fund) further," says Smith.
Unless the last few weeks turn horribly south, 2009 will turn out to be a banner year for closed-end fund investors. But what's next year likely to bring? More interests and challenges.
"As more and more investors retire, people are going to be looking for lots of alternative ways to try to shore up their income," says Smith. "And closed-end funds offer that opportunity."
But finding funds selling at deep discounts to their NAVs will be more challenging because discounts narrowed so much this year.
Jeff Margolin, a closed-end fund analyst at First Trust Advisors, says, "I believe closed-end fund investors need to choose the funds and categories of funds they invest in more carefully as they can no longer count on discount contraction to boost return."
That's not to say, however, that there won't be funds worth investing in, particularly for those who understand the market.
Herzfeld is looking forward to the upcoming buying season. Of the money he professionally manages, about two-thirds of it is sitting in cash. Even with this year's narrowing of discounts, he's confident there will be buying opportunities in December.
"Right now (interested investors) want to look at funds where the discount has become unusually wide," suggests Herzfeld. "And the way to measure that is to do their homework, buy our research, or look at what the average discount has been every week for the last year and then buy the fund if it's 5 percent wider than it has averaged."
In other words, Herzfeld said, he would consider buying a closed-end fund at a 15 percent discount if it normally trades at a 10 percent discount, as long as similar funds weren't trading at a 20 percent discount. "It (the discount) has got to be wider than its own average and wider than its peers."
For a few of Herzfeld's 2010 closed-end fund picks, check out his Web site (www.herzfeld.com) in late December.
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