Wednesday, August 29, 2007

Market Efficiency and Closed-End Funds


An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He says, “Hey professor, look, a twenty dollar bill.” The professor says, “Nonsense. If there were a twenty dollar bill on the street, someone would have picked it up already.” They walk past, and a little kid walking behind them pockets the bill.

If anyone you know is an efficient market proponent, all you have to do is point them to the closed-end fund space. Fear and greed play out in that arena as discounts and premiums (to NAV). Currently, there are a few opportunities popping up that are interesting.

ETF Connect has a great feature that lets you sort by discount and premium.

CUBA continues to trade at a large premium +40%, but finding any shares to short could be problematic.

DHG is managed by one of the best names in the business, and was getting pummeled to worse than a -20% discount and seems to have settled to around -10%. It is a l/s fund that is about 30% leveraged, and has a higher management fee of 1.42%

SNF is a Spanish CEF that trades at a 20%+ premium. A simple strategy would be to short SNF and buy the Spain ETF (ETFs rarely trade away from their NAV).

The Spain CEF highlights a characteristic you want to see when searching for CEFs at discounts/premiums - the price oscillates around the NAV on both the positive and negative side (some funds chronically trade at a discount with no catalyst for closing that gap). James Altucher has some good coverage of closed-end fund arb in one of his recent books (Supercash), and also touches on a CEF portfolio for his Mom at Stockpickr. SNF has traded at over 100% premiums and greater than -20% discounts. Take note of the five-year period in the 90's when it traded at a constant discount.

Chen & Steers Closed End Opportunity Fund (FOF) is interesting in that it has a fund of funds model to invest in other closed end funds. This could be a great option for someone looking to buy a diversified portfolio. It holds 94 other funds, many of which are trading at discounts. In effect, you get a double-dip on the discount effect (and also a double dip on management fees which tally to ~ 2%). Currently it is at ~ -3% discount, and if that ever gets larger, the fund could be an interesting option.

Brett Arends has a good article over on on some other CEF's that are particularly attractive. He has another article out on an emerging debt fund trading at a discount that results in a 12% dividend yield.

Below is a table I whipped together of some various CEFs. The bottom section is some of the bigger buy-write funds. Data is from 8/27 close.

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.