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If you figure you’ve missed the boat on last week’s big market moves, think again.
Yes, stock and bond markets both took off on hopes that the Federal Reserve has finally gotten inflation licked, and that we may avoid a U.S. recession too. The regular mutual funds that most people own — things like
SPY,
VTI,
and
AGG,
— rose 2%, 3% or more.
But even as bullishness rises on Wall Street, big discounts remain in a well-established, but long-overlooked, corner of the mutual fund market. So-called “closed end funds” are regulated mutual funds, like the ones in your company’s 401(k) plan, but with one difference: They trade on the stock market, like stock, in say Tesla
TSLA,
or Apple
AAPL,
or Nvidia
NVDA,
That means their stock price can bounce around independently of how the fund’s underlying investments are doing. It also means that sometimes stock in the fund sells for a lot less than the value of its underlying investments.
That’s been the case for a lot of closed end funds for several years. Those discounts get especially big when ordinary investors are panicky, or nervous, or generally bearish. Many of them widened, a lot, during the slump of 2022.
And they’re still wide.
Just by using closed-end funds you could currently construct an entire diversified investment portfolio for maybe 90 cents or even 85 cents on the dollar. Or, to put it another way, you could get about $1.20 worth of investments for $1.00.
With as few as two or as many as eight funds you could put together a portfolio that’s very simple and traditional or more broadly-based, which might — so goes the theory, anyway — give you a better return for less risk.
Before I get into them, let me add a few caveats. There are nearly 700 closed-end funds out there, and most of them aren’t worth bothering with. Too many of them are weird little funds with obscure strategies and ridiculously high fees. And too many are the leftover detritus of aggressive marketing campaigns, where investment bank salesmen on 5% commissions hustled them to unsuspecting prey.
When I look at closed-end funds I want to see at least four things and preferably five.
First, I want a clear, fundamentally sound asset class or investment strategy that I would want to own at full price. U.S. small-caps, European bonds, precious metals, high-yield bonds: These things are fine. Weird and obscure hedge-fund strategies, maybe not so much.
Second, I want good management. A bad fund isn’t worth it at any price. I want a fund whose underlying assets have at least kept up with its underlying asset class.
Third, I want modest fees. Any fund charging 2% or 3% of assets per year can go jump in a lake — Superior for preference, though Huron will do.
Fourth, I want a big discount to net assets. I want a fund whose shares are trading at 95 cents, or 90 cents, or better still 85 cents on the dollar. Otherwise, why am I buying the fund?
Fifth and finally, I would like some mechanism whereby as an investor I’m actually going to reap the benefits of that discount. That typically means big regular distribution of fund earnings and assets, or a policy of buying back stock when the discount gets too big. Or it might just mean a fund whose discount typically narrows in the market when bullishness returns.
Bearing those five criteria in mind, I was able to find eight pretty simple closed-end funds that are worth a look. And because they range across multiple asset classes, someone could use them to construct an entire portfolio.
You’d want to do your own homework, of course. But it’s illustrative.
You could, say, construct a version of the famous “60/40” balanced portfolio by investing 60% in Adams Express
ADX,
a U.S. stock fund, and 40% in Western Asset Inflation-Linked Opportunities Fund
WIW,
a (leveraged) inflation-protected bond fund. Both sell currently for discounts of around 15%.
If you wanted to go further you could add Japanese stocks (abrn Japan Equity Fund
JEQ,
), small company U.S. value stocks (Royce Value Trust
RVT,
), U.S. junk bonds (Western Asset High Yield Defined Opportunities
HYI,
), energy stocks (BlackRock Energy & Resources
BGR,
), and gold and silver bullion (Sprott Physical Gold and Silver Trust
CEF,
). Rounding this out you could also add Source Capital
SOR,
a one-fund balanced portfolio of stocks and bonds managed by First Pacific Advisors, a well-known and cautious value firm run out of Los Angeles.
The management fees range from around 0.5% for Adams Express to 1.2% for BlackRock Energy and Resources, though if you include the interest cost of leverage WIW is currently paying 1.5%. (One of WIW’s biggest investors, incidentally, is Bill Gates.)
Meanwhile the discounts to net assets range from around 6% for HYI and CEF, meaning in both cases you are getting $1 in investments for 94 cents, out to about 15% for ADX, WIW and JEQ.
Naturally there are no guarantees that these funds — or indeed any others — will make you money, or save you from losing it.
Many closed-end funds offered great ways to make money after the Covid crash of March 2020. The underlying ssets recovered, and the discounts narrowed as well: A double win. Current discounts aren’t nearly as big as they got back then, but they are pretty hefty by historic standards.
Hypothesis: There’s a reasonable chance they will outperform if markets keep rising, and suffer less if they don’t. But only time will tell.
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