Buy This Asset Class While It’s On Sale

There’s a saying I’ve heard once or twice, but can’t find the origin of:

“The stock market is the only place where they hold a sale and no one shows up.”

If anybody knows the origin of this quote, please let me know.

Unlike regular goods, which see demand increase when their prices decline, investors have a tendency to flee stocks when their prices fall, rather than embrace them.

To growth investors, this makes perfect sense: a stock that is in a rising trend is more likely to keep rising.

But to value investors, these “sales” represent a market inefficiency, and opportunity.

I bring this up today because there’s an asset class—a certain type of investment—that has been on permanent sale since April of this year… and is still cheap.

I’m talking about Closed End Funds, or CEFs.

The primary distinction between CEFs and other funds is that CEFs issue a limited number of shares, like a stock, and hold a fixed amount of assets. The market value of all the assets held by a CEF is called its Net Asset Value, or NAV.

Most CEFs usually trade at a price that is pretty close to their NAV per share, like a mutual fund. But unlike a mutual fund, which is priced based on its NAV at the end of the day, CEF prices are determined by the market, like a stock. So sometimes, a CEF’s price diverges from its NAV.

When a CEF is trading above its NAV, you say that the CEF is trading at a “premium” to NAV.

When a CEF’s price is below is NAV per share, it’s trading at a “discount.”

You can find out a CEF’s discount or premium with this equation:

(Share price ÷ NAV) – 1

Or you can check the fund issuer’s website, which will usually show the fund’s discount or premium to NAV at the end of the last trading day.

Of course, there may be a very good reason that a CEF is trading at a discount. The fund’s management may have made negative changes in its distribution policy, or the fund may own assets that are out of favor.

And you can’t assume that a CEF’s price will always return to its NAV. CEFs can trade at a discount or premium to their NAV for years.

You can get a little more clarity on whether a CEF’s current discount represents a good value by comparing its current discount to its average historical discount. If a CEF usually trades at a slight premium to its NAV, and is now trading at a slight discount, that’s a pretty good indication of value.

And today, as I mentioned above, almost the entire CEF sector is “on sale,” thanks to the April interest rate shock.

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Several of our Digest Contributors have been taking advantage of the big discounts to add income-producing CEFs to their portfolios. Ine of them is Jack Colombo, Editor of the Forbes/ISA Closed End Fund and ETF Report and a CEF expert. We included one of his recommendations in the latest Dividend Digest, where he pointed out that in addition to trading at a big discount to its NAV, the fund is also trading well below its 52-week average discount.

He also thinks the fund will benefit from some sector-specific factors in the near future. Here’s his recommendation:

“The commodity space is generally thought to be independent of stocks and bonds, which are correlated to each other. This investment class may be in for some increased volatility as most commodities have ended their decade-long rise and are now vigorously fluctuating in response to many factors. Fear for the Suez Canal has caused energy prices to spike, while strikes in South Africa caused dislocations in the platinum markets. The various takes on the future of the Chinese economy has caused swings in iron ore prices and plans for coal production. The increased volatility can be harnessed by the use of commodity futures and options.

The Nuveen Long/Short Commodity Total Return Fund (CTF) is a unique closed end fund that invests in both directions in a number of different commodities. The fund is currently trading at $17.84 and has a monthly distribution that works out to a yield of 10.43%. It is trading at a –14.08% discount to its net asset value, while its 52-week average discount is only –3.90%.

“These shares are an exchange traded commodity pool and are classified as a partnership for tax purposes. Shareholders will receive a Schedule K-1. It invests in energy, agriculture, metals and livestock sectors and seeks to capitalize on opportunities in both up and down commodity markets. The fund was recently mostly short agriculture, livestock, metals and mostly long energy. Its current discount is the largest since the fund began trading.” – Jack Colombo, Forbes/ISA Closed End Fund and ETF Report, September 2013

Wishing you success in your investing and beyond,

Chloe Lutts Jensen

Editor of Investment of the Week

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