The few closed-end funds she favors include large company stock funds, such as Adams Express, General American Investors and Central Securities Corp. On the small stock side, Royce Micro-Cap Trust, she indicates, may be a good buy. If the stock market continues to perform well, the discounts on these funds could narrow to 8% or 9% from 15%, she believes.
Maury Fertig, chief investment officer of Relative Value Partners, a Northbrook, Ill., investment advisory firm, stays fully invested in a combination of closed-end and exchange-traded funds he expects to rebound from being historically undervalued. He favors closed-end funds because they are not widely followed by Wall Street analysts. There are few institutional investors in this market. Plus, the funds can use leverage at a lower cost than brokers offer retail clients. Leverage can boost yields and total return on the upside.
Like others, he's not buying closed-end bond funds because they are trading at a premium. At the end of last year, he profited from two Sun America closed-end funds that converted to open-end mutual funds. Those funds were SunAmerica Focused Alpha Growth Fund Inc. and SunAmerica Focused Alpha Large-Cap Fund Inc. When a closed-end fund converts to an open-end fund, investors get the net asset value of the fund.
This year, he bought the Nuveen Multi-Strategy Income Growth fund. The fund, now selling at a 15% discount to net asset value-compared with similar funds' 9% discount, is changing its investment objective to a bank loan fund from a stock and bond fund. Fertig expects the change will narrow the Nuveen fund's discount. The fund pays a distribution rate-comprising interest, income and accumulated capital gains-of 8%.
Fertig also favors the Eaton Vance Tax-Advantaged Dividend Income Fund, which is trading at a 13% discount to net asset value. The fund writes covered call options on its stock portfolio. In 2010, the fund cut its dividend and retail investors fled. He expects the stock price to rebound if the overall stock market performs well. The fund has a distribution rate of 11.9% annually because of dividend and call option income. Although that figure may also include some return of capital, the fund can write down the tax basis of its holdings as call options expire.
He expects the Royce Value Trust, which sells at an 8% discount, to perform well. That fund has been selling at a discount for almost two years because the company stopped paying dividends following the 2008 market meltdown. The fund's distribution yield in mid-February was 6%.
Fertig adds that well-managed diversified closed-end stock funds can optimize well in a portfolio of securities. So a large-cap fund, like Tri-Continental, which is selling at a discount, is as good a long-term investment as an open-end stock fund.
Before you commit to a closed-end fund, Mike Taggart, director of closed-end fund research at Morningstar, says you should analyze a fund's market price discount history. Some funds trade at a discount for an exceptionally long time and show little upside momentum.
Taggart recommends looking at Morningstar's "z" statistic on its Web site to determine if a fund's market share price should rebound. The statistic considers the current discount of a fund compared with its discount in the past, taking into account the volatility of the fund's share price. Funds that score below -2 on the "z" statistic are considered cheap and could rebound, narrowing the discount to the net asset value.
Currently, Morningstar's list of attractive top-rated closed-end funds to be evaluated include: H&Q Life Sciences Investors, which trades for 90 cents on the dollar, but the share price of the fund was up 15% in 2012 through mid-February. On the international side, the Templeton Dragon Fund sells at 90 cents on the dollar and was up 11% over the same period.