Closed-End Fund Advisors: The Scott Letter

The Scott Letter: Closed-End Fund Report^©
Published by Closed-End Fund Advisors, Inc.

June 2001, Volume I, Issue 2
George Cole Scott, Editor

New Closed-End Fund Investor Resource

Since late May of 2001, The Wall Street Journal has included a daily Closed-End Fund Table in their business section of the paper. Now investors can have an easier tracking and researching closed-end funds. We hope the financial press will continue to promote more information on these neglected but profitable forms of investment.

Closed-End Funds: A Simple Explanation

Closed-End Funds are similar to open-end funds. However, they offer investors professional management, diversification and significant advantages over open-end funds.

1.   Closed-end funds generally trade at a discount to their net asset value (NAV). For example, if the total market value of all securities in a closed-end fund was $100 million and there were 10 million shares outstanding, the NAV would be $10 per share. Historically, most closed- end funds have traded at a discount to NAV. Therefore, it is often possible to purchase shares of the fund for less than $10. Careful and prudent investors are continually trying to purchase one dollar of assets (as measured by the market price in this instance) for less than one dollar.
On the other hand, open-ended funds must trade at their NAV since investors can redeem their shares at NAV on demand. When an investor purchases an open-end fund, he receives exactly a dollar's worth of market value for his one dollar of investment.

2.   Closed-end funds provide investors with greater flexibility. A closed-end fund portfolio manager is never under pressure to sell shares in order to raise cash for redemptions. A closed- end fund does not redeem its shares — they are freely traded on the stock exchange exactly like stocks. In a weak market, an open-end fund (mutual fund) manager is often forced to sell shares at low prices in order to raise cash for redemptions. A closed-end fund manager can also buy into relatively illiquid foreign markets because the fund is free of the redemption pressures that could force it to liquidate shares in an unfavorable market environment.

3.   Investors can profit in two ways from investing in a closed-end fund: First, by identifying a fund that has the potential to increase in value, a profit can be made on the increase in net asset value. As this increase in value is noticed in the market, there will often be a tendency for the discount to narrow, thereby providing additional profits on the share price. For example, a closed- end fund with an NAV of $10 is purchased at a 10% discount for $9 a share. As the NAV moves up to $11 (a 10% gain), it is likely that the discount will decrease from 10%, a lesser number, in this example, to 6%. With an NAV of $11 and a discount of 6%, the price will be 10 3/8. The NAV has gained 10%, the market price has appreciated 15%. While this does not always happen, we feel there is reason to believe funds we own will narrow their discounts over time. Investors, must, therefore realize that performance can be good without a narrowing discount

Secondly, funds that trade at a discount can use one of two techniques to benefit the shareholder. The fund can either make a tender offer at NAV or the fund's shareholders can vote to open-end the fund. Either event will cause the share prices to equal the NAV.

New NYSE Closed-End Fund

The Common shares of Cohen & Steers Advantage Income Reality Fund, Inc. (NYSE: RLF) headquartered in New York City, began trading on May 25th 2001. Cohen & Steers is a closed-end investment company that invest in real estate securities.

A World of Investment Opportunity

Today there are over 560 closed end funds trading on U.S. national exchanges. This includes the new Exchange-Traded Funds (ETFs) which are funds trading on exchanges, but can be redeamed like mutual funds. Virtually every segment of the market is represented. Equity funds include domestic funds that invest in blue chip, small capitalized growth, health care, energy, real estate, utilities, etc., and foreign country funds throughout the world. Corporate bond funds, multi-sector funds, convertible bond funds round-out income portions of portfolios.

If your portfolio contains only U.S. stocks, you are missing out on about 60% of the world's investment opportunities. A sense of missed opportunity is created when one studies world stock market performance over virtually any period in the last decade. Since 1976, the U.S. percentage of world market capitalization dropped steadily. In 1980, the investor participating only in the U.S. market had access to about half the world's stock market value. The case for global diversification is compelling when you consider that the domestic market represents about 40% of the world market and is decreasing each year.

A balanced portfolio today must be invested in global stock and bond markets in order to enhance long-term market performance. Closed-end funds, often available at substantial discounts to net asset value, offer the most accessible mechanism for achieving cross border diversification for investment portfolios.

The editors of The Scott Letter Online are interested in any feedback from our readers regarding how we may improve this publication. Comments concerning topics in which you agree or disagree are also of interest to us. Your opinions are valuable and will help us to be able to serve you better. Please send your questions or comments to our email address or by regular mail prior to the next edition or The Scott Letter Online. We do read your letters, but we cannot guarantee they will be published in The Scott Letter.

Note: None of the information contained herein should be construed as an offer to buy or sell securities or as recommendations. Performance results shown should under no circumstances be construed as an indication of future performance. Data, while obtained from sources we believe is reliable, cannot be guaranteed.

1.	Closed-end funds generally trade at a discount to their net asset value (NAV). For example, if the total market value of all securities in a closed-end fund was $100 million and there were 10 million shares outstanding, the NAV would be $10 per share. Historically, most closed- end funds have traded at a discount to NAV. Therefore, it is often possible to purchase shares of the fund for less than $10. Careful and prudent investors are continually trying to purchase one dollar of assets (as measured by the market price in this instance) for less than one dollar. On the other hand, open-ended funds must trade at their NAV since investors can redeem their shares at NAV on demand. When an investor purchases an open-end fund, he receives exactly a dollar's worth of market value for his one dollar of investment.
2.	Closed-end funds provide investors with greater flexibility. A closed-end fund portfolio manager is never under pressure to sell shares in order to raise cash for redemptions. A closed- end fund does not redeem its shares — they are freely traded on the stock exchange exactly like stocks. In a weak market, an open-end fund (mutual fund) manager is often forced to sell shares at low prices in order to raise cash for redemptions. A closed-end fund manager can also buy into relatively illiquid foreign markets because the fund is free of the redemption pressures that could force it to liquidate shares in an unfavorable market environment.
3.	Investors can profit in two ways from investing in a closed-end fund: First, by identifying a fund that has the potential to increase in value, a profit can be made on the increase in net asset value. As this increase in value is noticed in the market, there will often be a tendency for the discount to narrow, thereby providing additional profits on the share price. For example, a closed- end fund with an NAV of $10 is purchased at a 10% discount for $9 a share. As the NAV moves up to $11 (a 10% gain), it is likely that the discount will decrease from 10%, a lesser number, in this example, to 6%. With an NAV of $11 and a discount of 6%, the price will be 10 3/8. The NAV has gained 10%, the market price has appreciated 15%. While this does not always happen, we feel there is reason to believe funds we own will narrow their discounts over time. Investors, must, therefore realize that performance can be good without a narrowing discount