Tom Quillen from Chattanooga writes:
I have been a student and investor of closed-end funds for many years — I think since reading about them in one of your books.
I have bought most at large discounts on the premise that they will either reduce their discount or open end. In fact, I had one last year that did open end, providing an immediate 10% return. I think it was the AIM something fund. [Ah, the AIM something fund. I know it well. — A.T.]
(1) I am appalled at the number of fund managers that have provisions to put a closed-end fund to a vote to open end if the discount is large enough, but always manage to keep the vote from passing. If a closed-end fund is trading at a large discount, it is in EVERYONE’S interest, except the fund manager’s, to open end or liquidate. [A closed-end fund may own $10 million worth of stock but be selling for, say, only $7 million — a million shares trading at $7 each. That would be a 30% discount to net asset value. If you own stock in the fund, you sure wish you could get your hands on your share of the underlying securities and sell them — you’d get full price. When a closed-end fund goes open end, that’s essentially what happens. It no longer trades on the New York Stock Exchange (or wherever) as it did before. Instead of “selling” your shares at a discount, through a broker, as you would have had to before, now you’d “redeem” them at net asset value dealing direct with the fund. (The fund redeems your shares either with some new buyer’s cash, or else by selling some of the stocks or bonds it owns.) So your $7 shares suddenly would be worth $10 each, in this example, if the closed-end fund went open end. — A.T.]
(2) I buy closed-end funds on the assumption that the average closed-end fund performs as well as a similar open end fund. After all, they are by and large the same managers, and I assume that if there was a large gap between the performance of the two that you and other responsible financial reporters would widely report it. [Actually, closed-ends that sell at a discount might be expected to perform better, to the extent that you’ve got $1 worth of capital at work for every 70 cents or 90 cents you’ve invested. Then again, the closed-end funds with the biggest discounts often include those that are most poorly run, with the worst track records. The market isn’t entirely irrational. — A.T.]
(3) I am beginning to lose patience with some of my closed-end funds. Admittedly, most are one-country funds, which have not done too well of late. But I am beginning to think that a large discount in a closed-end fund can go on forever. I once thought any large discount would shortly be arbed out, but this is not happening, even in this bull market.
Tom: not only can the discounts go on forever. In a bear market (should we ever have one again), they will widen. Some, sharply.
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Selling a soybean contract short is worth two years at the Harvard Business School.~Robert Stovall
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