Investors who are seeking yield in a low-return environment are finding pockets of opportunities in the peculiar world of closed-end mutual funds.
Despite a narrowing of the discount between the price of closed-end-fund shares and the value of the funds' underlying investments — which led to considerable gains in the past year — there is still money to be made, according to analysts.
“There are solid funds out there trading at discounts,” said Mariana Bush, a closed-end- and exchange-traded-funds analyst with Wachovia Securities LLC. “One has to be a fund picker.”
Investors also must understand the nuances of closed-end funds, which issue a fixed number of shares in initial public offerings and trade on exchanges. As a consequence, the price of a closed-end-fund share is determined entirely by market demand, with shares trading at either a discount or a premium to their net asset value.
Ideally, investors buy closed-end-fund shares at as deep a discount to net asset value as possible, meaning that each dollar invested may be buying shares worth considerably more.
A year ago, the average discount among closed-end funds was more than 11%. But over the past 12 months, discounts have narrowed.
At the end of last month, the median discount of all closed-end funds narrowed by 92 basis points to 3.95%, well below the 12-month average of 6.66%, according to Lipper Inc.
Demand for fixed-income closed-end funds drove down the discount in that category by 65 basis points to 2.44%, while the median discount for equity closed-end funds narrowed by 104 basis points to 8.06%.
Only world income funds and single-state muni bond funds experienced a widening of discounts.
Investors who bought closed-end funds a year ago made quite a bit of money, but “those deals aren't there anymore,” said Tom Roseen, a senior research analyst at Lipper. Nevertheless, the Lipper data suggest there still may be room for equity closed-end-fund discounts to narrow.
Seeking such opportunities is Cecilia Gondor, executive vice president at Thomas J. Herzfeld Advisors Inc., which manages $100 million in closed-end funds.
A number of equity funds re-cently cut their distribution payments and are trading at “persistent, wide discounts,” making them more attractive, she said.
Such funds include the $121.8 million Liberty All-Star Growth Fund Inc. (ASG), from Alps Advisors Inc., and the $145.2 million Gabelli Global Multimedia Trust Inc. (GGT), from Gabelli Funds LLC, which on March 3 were trading at discounts of 12.35% and 13.03%, respectively.
Ms. Gondor's list also includes the $146.6 million SunAmerica Focused Alpha Large Cap Fund Inc. (FGI) and the $309.2 million Sun-America Focused Alpha Growth Fund Inc. (FGF), both from Sun-america Asset Management Corp. On March 3, the funds were trading at discounts of 8.08% and 9.34%, respectively.
Several of these funds have traded for an extended stretch of time at wide discount levels, attracting the attention of “dissident” shareholders looking to make changes to the funds, Ms. Gondor said.
It is a good bet that when such investors get involved, the funds will do something to address their concerns, leading to a narrowing of discounts, she said.
Because of the bimonthly or quarterly cash payouts, even closed-end funds with narrow discounts can be appealing to investors seeking income.
One corner of the closed-end world which may interest investors involves funds that invest in natural-resources master limited partnerships, said Patrick Galley, chief investment officer of RiverNorth Capital Management, LLC, which manages $500 million.
While such funds are now trading at a premium to their net asset value, they're attractive in the present low-yield environment because the partnerships don't pay income tax and pass along earnings to investors as dividends, Mr. Galley said.
For example, the $1 billion Tortoise Energy Infrastructure Corp. (TYG), from Tortoise Capital Advisors LLC, which traded at a premium of 8.95% to net asset value March 3, has an annualized distribution rate of 7.08%, payable quarterly.
Moreover, MLPs within a closed-end fund are more suited to qualified retirement accounts than would otherwise be the case because master limited partnerships, owned directly, trigger the unrelated-business taxable income tax, which could jeopardize a plan's tax-deferred status.
[More: Closed-end funds for retirement income: Why anxious retirees should consider closed-end funds]
Continuing investor appetite for closed-end funds probably will lead to a number of closed-end-fund IPOs in the coming months, observers said.
“There is an opportunity to put money to work,” said Anne Kritz-mire, a managing director with the closed-end fund and structured products group at Nuveen.
Last month, the initial public offering of the Nuveen Mortgage Op-portunity Term Fund 2 (JMT), from Nuveen Investments LLC, raised approximately $135 million. Also last month, the IPO for the Western Asset Mortgage Defined Opportunity Fund (DMO), from Western Asset Management Co., the fixed-income unit of Legg Mason Inc., raised approximately $218.5 million.
Both came on the heels of IPOs in January for the ING Infrastructure Industrials and Materials Fund (IDE), from ING Investments LLC, which raised $370 million, and the Federated Enhanced Treasury Income Fund (FTT), from Federated Investors Inc., which raised $178 million.
E-mail David Hoffman at [email protected].
