CEF Discounts Approaching 1999 Nadir

by: Joe Eqcome October 31, 2008 | about stocks: CET / EDF / GDL / HQH / MCR / MMT / PEO / SBG / SBW    

Joe Eqcome

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The percentage of Closed-End Funds (“CEFs”) whose share prices are currently trading at a discount to their Net Asset Values (“NAV”) is approaching the cyclical record low (high percentage) of 1999. Currently, 95.3% of all CEFs are trading below their respective NAVs as of 10/29/08. The group’s aggregate average discount is currently -11.8%. This is approaching the record year-end level of 1999 when the percentage of CEFs trading at a discount to NAV was 96.7%. At that time the aggregate average discount was -13%. (The stock market troughed in August of 1998.)

click to enlarge images

Many technical analysts cite CEF discounts as one factor in looking for a stock market bottom. Large CEF discounts are symptomatic of retail investors’ panic selling—typically coinciding with a market bottom. Whether we’re at a market bottom can only be determined in retrospect. Nonetheless, we’re probably closer to a stock market bottom than to its top.

Can lightning strike twice? My analysis included those 212 CEFs that were “going-concerns” continuously from 1993 to present (10/29/08=2008). I looked for those CEFs that showed the greatest total return in the calendar year 2000—following the 1999 CEF discount trough for which numbers were available.

The top 5 CEFs with the greatest total return are depicted in the chart below. Whether these CEFs could again benefit from a recovery in 2009—if 2008 is a trough year for CEFs’ discounts—is subject to the unique economic and capital market factors indigenous to this cycle; but, what we know factually is this: these CEFs did recover from the deep 1999 trough.

Current CEF Screen: I also ran a screen for current CEFs which might be attractive investments based upon the following characteristics: 1) greater than $200 million in total Assets; 2) no Adjustable Rate Preferred stock; 3) expense ratio less than 1%; 4) discount of at least -15%; 5) share price declines greater than declines in NAV. Those stocks are as follows:

Disclosure: Author holds long positions in HQH, PEO, MCR

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This article has 8 comments:

  •  
    Oct 31 07:22 AM
    how about CEF itself.
    Reply | Link to Comment
  •  
    Oct 31 09:59 AM
    The average total return for the study group for which I had data available was 25.9%.
    Reply | Link to Comment
  •  
    Oct 31 11:29 AM
    Why are your figures far off?


    H & Q Healthcare Investors (HQH)
    Closed-End ETFs
    ----------------------...
    Fund Quick Facts
    As of 10/30/2008
    Closing NAV: $14.11 Current Distribution Rate: 10.82%
    Closing Share Price: $12.20 Premium/(Discount): -13.54
    Reply | Link to Comment
  •  
    Oct 31 11:31 AM
    When I see an NAV below the inception price, it tells me the fund has not earned its distributions and you are getting alot of return of capital. What's so good about that?
    Reply | Link to Comment
  •  
    Oct 31 02:57 PM
    Your figures for HQH are correct for the date for which you sighted them--which makes the case for HQH that day even more compelling then presented. Thanks for the catch.
    Reply | Link to Comment
  •  
    Oct 31 04:10 PM
    There are many reasons why a CEF's current NAV might be below its original offering price. You're right in that one of the reasons may be it is paying a dividend in excess of its income.

    However, depending on the CEF fund type, the more likely reason for a decline in NAV from its offering price may be the value of its portfolio has declined--due to market forces or events specific to its stock holdings. The investment rationale for buying the stock is that the CEF’s portfolio holdings may recover thereby driving up the stock of the CEF above my purchase price.

    This may be somewhat similar to a builder who built a house costing $1 million. Due to declining housing values, I could buy it from him for $800,000. Why should I care that it cost him $1 million to build as long as I felt it was a value for me at that price?

    It similar to an investor who purchased a CEF stock at the original offering price, I don't particularly care what he purchased it for as long as I think it’s a good value for me at the price I pay at that point in time.
    Reply | Link to Comment
  •  
    Oct 31 04:42 PM
    CEF is the symbol for a Canadian gold and silver depository.
    Reply | Link to Comment
  •  
    Nov 01 11:56 AM
    CEF was trading at a 6.3% premium at 12/31/99 and the following year (2000) the share price declined -23.6%.

    Precious metals are typically a top/early bear stock market investment for investors looking to protect themselves from increasing stock market uncertainty. So, it might make sense that it would underperform in a market recovery. Other precious metal ETFs include IAU, GLD, SLV & DBS--all have short histories. CEF is currently trading at a 11% premium.

    If you plot CEF against the S&P 500 you'd see an inverse relationship during the 1998-2002 periods. However, in 2008 the stocks seemed to trade in tandem as the market tanked. This still might be a good "short" possibility if the historic relationship between the two reasserts itself (long SPY; short CEF). Talk to your financial advisor before making such a trade.

    Below is a URL to CEF at ETFConnect.com that has an abundance of data on CEF. www.etfconnect.com/sel...
    Reply | Link to Comment
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