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Wall Street, California | Fund Strategies

Thinking Foreign? Closed-End May Be the Ticket

November 03, 1998|PAUL J. LIM | TIMES STAFF WRITER

Global financial markets have come roaring back in recent weeks. That may have more investors thinking about easing back into the deep end of the pool--perhaps into an emerging-market stock mutual fund or other higher-risk market sector.

If you're in the market for risky funds, consider "closed-end" portfolios. You have a chance to get many of them on sale.

Closed-end funds--unlike the open-end variety most investors are more familiar with--are mutual funds whose shares trade on the major exchanges, just like stocks.

This gives a closed-end fund two prices--and, some would argue, gives both the funds and their investors an advantage.

As with its open-end counterpart, a closed-end fund has a price that reflects the current value of its holdings, known as its net asset value, or NAV, per share.

But contrary to an open-end mutual fund, a closed-end fund has a second price--the price at which its shares are bought and sold on the public exchanges. This is its market price. And this is the price that determines how much a closed-end fund investor makes or loses on the investment.

If a fund's market price is below its NAV per share, it is said to be trading at a discount to true value. If, for whatever reason, investors bid a fund's market price above its NAV, then it is trading at a premium to its true value.

Notes Ronald Olin, president of Deep Discount Advisors, a money management firm in Asheville, N.C., that specializes in closed-end funds: "You can use the discount as a simple barometer of value. The bigger the discount, the better the value" in a closed-end fund.

The good news for investors is that many closed-end funds now trade at huge discounts to their NAVs.

Indeed, the typical closed-end emerging-markets stock fund is trading at a 16.1% discount to NAV, according to CDA/Wiesenberger, a fund researcher in Rockville, Md.

This means that you can literally buy $1 worth of emerging markets stocks in the typical portfolio for 84 cents.

Take Scudder New Asia. Its shares closed Monday at $9.25 apiece on the New York Stock Exchange. But as of Friday, the fund's net asset value--the liquidation value of its holdings--was $10.69 a share, according to Bloomberg News.

That means Scudder New Asia shares were trading for 13.5% below what they were actually worth.

Sounds like a great deal. But if closed-end funds like New Asia are such screaming bargains, why isn't everyone investing in them?

It's a which-came-first, the-chicken-or-the-egg issue.

Over the years, investors have overwhelmingly favored open-end mutual funds, while demand for shares of closed-end portfolios has been modest. Without an influx of buyers, shares of many closed-end funds have remained at discounts for simple lack of interest.

But one could also argue that the reason closed-end fund demand has been so weak is that many closed-end fund shares seem to perpetually trade at discounts to NAV.

Nonetheless, analysts say closed-end funds are worth considering--especially now.

In addition to the big discounts to true value, the closed-end model itself is seen as having an advantage for portfolio managers and thus for long-term investors, especially when investing in risky, out-of-favor sectors.

Most stock fund managers tend to be fully invested--meaning they invest nearly every dollar plowed into the fund into the market. That leaves them with little cash. Should investors want out of an open-end fund, the manager would, in all likelihood, have to begin selling stocks to cash out investors.

This selling can hurt the fund's performance--because the manager may have to sell stock winners in the process. Indeed, redemptions have been a major concern for open-end fund managers during the recent market slide.

Not so for closed-end funds. Once their capital is raised and invested, "There aren't any withdrawals or redemptions" from closed-end funds, noted Gregg Wolper, closed-end funds editor for Morningstar Mutual Funds. "It's a way to protect against a run on the fund."

From a fund manager's perspective, then, the closed-end structure creates a more stable environment for stock picking. That may be one reason the NAV of the typical closed-end emerging-markets fund fell 26.1% between Jan. 1 and Oct. 23, while the average open-end emerging-markets fund fell 31.9%, according to Lipper Analytical Services.

Where should an investor considering closed-end funds begin looking today?

There are closed-end funds investing in each of the main market sectors--U.S. stocks, U.S. bonds and foreign stocks and bonds.

One option for investors who are adjusting their open-end fund portfolios at year-end is to look for a closed-end fund in the same sector.

For example, if you are planning to sell an open-end fund to lock in losses that you can use to offset capital gains, consider taking some of the proceeds of those sales and investing in a closed-end fund that invests in similar securities.

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