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Crazy Action in Closed-End Mutual Funds:

Closed-end mutual funds, which have a fixed number of shares and are traded on stock markets, have been absolutely clobbered by the turmoil in the financial markets. Not only have their underlying net asset values gone done, but many of them are trading at historically high discounts to net asset value. There are even some municipal bond funds that normally trade at premiums that are currently trading at 25% or so discounts (in part because they are leveraged, but still, a 25% discount on a fund that will likely eventually regress to its historical mean of a small premium leaves a lot of room for error).

I'm not a fortune teller, so I don't know whether this is a good time to invest or not. But I do know that if I owned an open-end fund, especially if I had a tax loss I could take, I'd be shopping around for a similar closed-end fund with a massive, historically unprecedented discount. For example, why own an open-end emerging markets income fund when you can own EDD at a 32% discount? (Disclosure: I don't own this fund.) Why own an open-end corporate bond fund when a couple dozen closed-end corporate bond funds are selling at >25% discounts? And so on.

Two good websites for closed-end funds: www.cefa.com and www.etfconnect.com.

Related Posts (on one page):

  1. Closed-End Funds Update:
  2. Closed-End Funds and Panic Selling:
  3. Crazy Action in Closed-End Mutual Funds:
11 Comments

Closed-End Funds and Panic Selling:

I posted a few days ago about the crazy action in closed-end mutual funds. At the end of the week, the action got even crazier. As of market close on Friday, the median closed-end fund was selling at slightly under a 30% discount to net asset value. In other words, investors could buy $100 worth of securities for just under 70 dollars.

This is simply extraordinary. In normal times, the average discount for a closed-end fund hovers around 5%. In bad times, it may go to 15%. Since the Great Depression, only in the early 80s has it gone above 20%, just before the great bull market that started in 1982.

To give you an example of the discounts that are out there, one single-state municipal bond fund closed at a net asset value of 11.21, with the last trade at $6.69, a 40% discount to net asset value. Earlier in the day, the fund sold for as low as $5.01, meaning that you could have bought $100 worth of underlying assets for less than $45. A few months ago, the fund was selling at a 10% premium to Net Asset Value. If such funds don't regress to something close to their historic mean discounts, investors will inevitably demand (with varying degrees of success) that the funds liquidate and distribute the proceeds to their shareholders--a fund selling at a 40% discount can return greater than 60% to shareholders by open-ending.

While municipal bond funds carry some risks that their underlying net asset value is misreported, and also some risk relating to the leverage they employ, even plain vanilla conservative stock funds are selling at historically high discounts of 25% or more. At least one fund that invests mainly in treasury bills and cash is selling at a close to 30% discount.

Unlikely other publicly traded securities, closed-end funds are primarily an investment vehicle of individual investors. Other such vehicles, such as master limited partnerships and Canadian energy trusts, are also getting absolutely hammered with little regard for fundamentals.

This all suggests to me that we are truly in a state of panic-selling, and, of course, that many closed-end funds are currently a bargain relative to purchasing the underlying securities. Panic-selling usually denotes the opposite of the buying frenzy at the end of a bubble market, that is, that a bear market is ending. But given the instability we have seen in the markets of late, I wouldn't bet the house on it.

UPDATE: CEF's that were trading at huge discounts Friday afternoon are almost universally up 10% or more with today's rally.

UPDATE AFTER MARKET CLOSE: Closed end funds soared today, as did the MLPs and energy trusts mentioned above. The single-state mutual fund I mentioned above was up 30% today.

Related Posts (on one page):

  1. Closed-End Funds Update:
  2. Closed-End Funds and Panic Selling:
  3. Crazy Action in Closed-End Mutual Funds:
15 Comments

Closed-End Funds Update:

I've been blogging about the crazy action in closed-end funds, mutual funds that sell on the exchanges and have a fixed number of shares. Because the funds are thinly traded and held mostly by individual investors, they can sell at large discounts or premiums to their underlying net asset value, depending on investors' optimism or pessimism.

In normal times, the average closed-end funds sells at about a 5% discount. On Oct. 10, the median fund was selling at an almost 30% discount, a historically unprecedented discount, and evidence that individual investors were in a selling panic. Some individual state municipal bond funds fell to greater than a 50% discount during the day on Friday.

A week later, with the markets calmer, less that 15% of CEFs are selling at even a 20% discount. Some of the state municipal bond funds that had completely crashed are now selling at premiums (see BPS, for example).

The discounts are still higher than usual, as one might expect given the turmoil on Wall Street. (Also, CEFs in any event tend to sell at relatively high discounts from October to December, and their discounts narrow, predictably, in January.) But absent a further shock to the system (such as a major international bank failing, or a major terrorist attack) the action in closed-end funds suggests that irrational pessimism reached a zenith on October 10th, and that is very likely to wind up being the market bottom.

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