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

May 2001, Volume I, Issue 1
Adams Express and Petroleum & Resources
George Cole Scott, Editor

Interview with Doug Ober,
Chairman and CEO
Adams Express and
Petroleum & Resources

Adams Express Company (ADX-NYSE) and its sister fund, Petroleum and Resources Corporation (PEO-NYSE), are two of six closed-end funds serving investors since the 1920's. The others are Central Securities, General American Investors, Salomon Brothers Fund and Tri-Continental Corp.

The Adams Express name comes from a transportation firm going back to 1840 which, with Wells Fargo and American Express, became one of three principle express companies in the United States. Adams was so profitable that it invested a large percentage of its profits in an equity portfolio structured as an investment company over the years. In October, 1929, just before the stock market crash, Adams Express evolved into a closed-end fund. At the time, there were over 500 closed-end funds, representing the principle way for individuals to participate in the booming stock market. After the crash, 46 funds survived the Depression. Petroleum & Resources, which also became a public company in 1929, consists principally of equities in energy-related companies and today has assets of over $500 million.

Except for the years 1867, 1869 and the depression years 1932-35, Adams has paid dividends every year since 1854. In 1976, it moved operations from New York to Baltimore. Today both funds have over $2 billion in assets and employ a staff of 20 people including research analysts, portfolio managers and administrative personnel.

We believe that the following interview will not only educate and explain how Adams Express works, but how and why closed-end funds in general work. George Cole Scott interviewed Doug Ober, Chairman and CEO of the two funds, on May 3, 2001.

Scott: You and your associates have done a great job of educating the public about our industry through meetings with investors, frequent reports and your web site where you give information on your two funds.

It is significant that you as well as half of the equity funds and three quarters of the bond funds now report net asset values daily in the media. The Wall Street Journal and other newspapers report them weekly, and the daily figures are available in The Wall Street Journal Interactive edition and on the Closed-End Fund Association’s web site. ( This is a great step forward in our industry.

We have been investing in Adams Express for over 20 years now and still see it as a core holding for any portfolio. In spite of this, many investors still do not understand how closed-end funds work.

Ober: I know. The Closed-End Fund Association (CEFA) has been working hard to get the word out. In the past two years the publicity has been much more of a plus than a minus. If we can get Dow Jones to take a different slant on the industry, that would be wonderful. But, that is swimming upstream.

Scott: Is anyone working on that?

Ober: I think Brian (Brian Smith, Director of the Closed-End Fund Association) has been trying to expand our coverage. There has been talk of listing NYSE closed-end funds daily in a separate table as Dow Jones and others do on weekends rather than with the other listed stocks. This is part of an effort to shrink the coverage of what doesn't seem to be of interest to everybody this week and balloon the coverage of what is of interest. Nothing has come of this yet, however. And now, suddenly, we see a great deal of information and more coverage on a new variety of funds called Exchange Traded Funds. (ETFs are index-based funds that trade on exchanges close to their net asset values because they can be redeemed like mutual funds).

Scott: That's interesting as Professor Fredman and I are preparing a new book on Closed-End Funds and ETFs. The book will be published by a distinguished university press and may be titled "Tradable Funds". We will compare and contrast the two types of funds. We will keep this web site posted on its progress. Our previous book, Investing in Closed-End Funds, is now out-of-print but a few copies may be found on web sites such as The book is also available in many libraries.

Getting back to ADX, you list preservation of capital as the first of three objectives of the fund. The others are reasonable income and opportunities for capital gains. Could you describe how each of these applies to your portfolio strategy and how they fit together?

Ober: These objectives go back at least two generations of management to George Clark, who ran Adams for twenty years. We, therefore, have the continuity of three managers with 40 years of history in managing these two funds.
The first objective is preservation of capital, something that we strive to do. In the most recent quarter we haven’t done as well as we might have. Over the years, we have limited risk in the portfolio through a number of specific ways. One is to invest in convertible securities which have less downside risk than common equities generally do. In the Adams portfolio, we currently have about 71⁄2% invested in convertibles, a near doubling from the year-end.

Scott: I looked through your last report and found most of the convertibles are in the telecommunications sector rather than in the technology stocks where you really needed them to stabilize the fund in the past six months. Why is this?

Ober: There have not been any convertibles of which the parent company has been of interest to us. There are many convertibles out there in such names as Cisco and Oracle, but, when you look at one in the secondary market with a 4% yield and a 95% premium, that’s not a convertible I am interested in. I want to own a convertible that has downside protection, such as a 25% premium and a nice coupon of 5% to 6%. For instance, our Canadian National Railway 5.25% converts are an attractive piece of paper. We own several others that meet our criteria. This is one way that we make an effort to preserve capital. We generally do not own highly volatile stocks but keep ourselves in the large cap arena. Over 75% of the portfolio is in stocks with a capitalization of at least $8 billion. I would say at least 75% of our portfolio securities have capitalization's in excess of $12 billion. The large-cap stocks tend to be less volatile than the smaller names. That’s how we make an effort to preserve capital.

Probably the foremost way we invest is our use of a team of analysts here who are working to uncover interesting investments rather than having to rely heavily on Wall Street research. Instead, we go out and meet with the managements of companies, investigate the industries and make decisions on that basis. I think this is the most important aspect of our operation.

For income, we use convertibles which yield more than the low S&P rate which is about 1%. We also write out of the money call options so if it reaches the call price, we are happy to sell the stock. We don’t use this strategy for more than 1% of the portfolio, however. We also write put options and have the ability to buy options, but haven’t done this as yet. Income from our option writing program has averaged $1 million dollars a year for the past five or six years; it is income that we might not otherwise have. We also have a relationship with the Bank of New York to lend out stocks in the portfolio(for cash) to their other clients.

The opportunity for capital gains results from a significant number of names in the portfolio which don't pay dividends where the long-term outlook is particularly good. They are the higher growth element of the portfolio. That does not necessarily mean higher risk, but, in some cases, it does. There are a lot of companies which don't pay dividends because they are investing in businesses which we expect to grow the fastest in the next few years.

Scott: How do you think Adams Express and Petroleum & Resources differ from similar mutual funds?

Ober: Three things jump out at me: First, we are internally managed and don’t have an outside manager focused on 15 or 30 funds within a fund family like mutual funds. Secondly, we only have two funds and two groups of people within our organization doing the day-to day work for them. Those connected with ADX or PEO only work for one of these funds and no-one else. They are all employees of the particular fund, not of a management company that has a contract to manage the fund. I can invest my paycheck from each fund in shares of both companies through our 401k and stock option plan. As a result, I am a substantial owner of shares in each fund. (The latest proxy shows Doug Ober owns 99,559 shares and the executive officers of the as a group own 731,919 shares or 0.9% of the common stock outstanding of ADX as well as a significant number of shares in PEO). As employees, we are shareholders of both funds and are tied very tightly to them. That is true of all the people who work here. As shareholders, we are very much interested in improving the net asset value and market value of both funds. Few mutual fund managers can say that.

There are two other reasons why we differ from mutual funds: our expense ratios are lower, and we are internally managed. This means we can give a better return to our shareholders.

Scott: We calculated the expense ratio for Adams Express for the last five years to be 0.30% or 30 basis points.

Ober: That is a good five year average. For PEO, which is smaller, it is 65 basis points but still is about one half of your average mutual fund. We also have a lower portfolio turnover, which for Adams, has averaged about 17.5% over the last five years. The average mutual fund is running about 95% or more. Our portfolio is turned over, on average, once every five to six years. The funds are more tax efficient than many funds because we have held some companies in the portfolio for over 20 years. This is indicative of the long-term view we take toward investing.

To summarize, the internal management, the low expenses and turnover ratios are the biggest differences between us and your average mutual fund.

Scott: Many investors we talk to still don't understand how the discount benefits the investor. Would you tell us how it helped your returns last year?

Ober: Sure! In the year 2000, the discount for Adams Express for the first quarter was 13.7%. At the end of the first quarter of 2001, it was 10.1%, a three and one half percent narrower discount for ADX. For PEO, it narrowed from 18.3% to 16.5%. What that means is that at the beginning of the year 2000, in Adams case, you could have paid eighty seven and a half cents on the dollar for the net assets in the fund. The net assets at the time were $1.9 billion, and the discount at 13.7% was higher than is today. The market value of the shares is now closer to the net asset value of the investments in the portfolio. If we were a mutual fund trading at net asset value, the assets would have increased by perhaps 10%. Because the discount narrowed in that period, the return to our shareholders was 11.5% due to the narrowing of the discount. That's how the discount works to the shareholders' advantage.

Scott: Do you think the share repurchase program played a big part in the narrowed discount?

Ober: I don't think so, but I believe it has had some impact. I think the primary reason has been our performance over the past three or four years and the recognition of this has been the primary factor in narrowing the discount. I think the share repurchase has alerted people that we are interested in what the discount is doing. People who might not invest in a closed-end fund might consider doing so because we are taking an active role in this issue. All of the academic studies show that as long as the fund is buying-in the stock it has an effect on the discount, but, when this activity stops, the discount starts to widen again. In the case of Petroleum, it narrowed substantially last year. We wanted to see if buying the shares was making a difference so we stopped buying-in the shares for three months. We found the discount continued to narrow because people were interested in purchasing that particular fund.

Scott: Adding to your observations, research provided to us by Lipper Inc. shows the discounts on many funds narrowed this year because of declining interest rates and diminished fears of a recession. There has also been more demand for closed-end funds. In spite of this, buying-in shares is still a low cost way of offsetting the dilution caused by the issuance of new shares for year-end distributions. It also raises the net asset value of the fund. You may not agree with this, but that is our view.

Adams Express holds 1.9 million shares of Petroleum & Resources or about 2.7% of the portfolio. It also holds a total of 10.9% in Petroleum & Resources, an energy fund, or about 2.7% of the portfolio so your shareholders will be able to participate in this industry if your projections are right. They can also buy PEO at a discount. Couldn’t this narrowing trend reverse itself and hurt your performance?.

Ober: Yes, it would without question. However, if you look at a longer time horizon, the discount varies around an average. In PEO's case, it has averaged 7 or 8 percent and is today 8.1%. If one is looking for a fund investing in the energy industry with good returns, it is an appealing choice for investing in energy with a clearer outlook than the technology or telecommunications sectors have. We think the oil and gas companies will continue to report very exciting numbers and that this will continue for some period of time to come. The energy stocks have reflected that assessment, and, we think, still have a long way to go. In this case, you may care less about the discount. Follow that rational?

Scott: Yes. And looking at your portfolio at year-end, we find you had 26% in technology stocks and 10.8 % in communications. You mentioned your technology sector pulled your net asset values down earlier this year. What are your comments about this and your thoughts on the recovery of technology stocks which seems to be a controversial issue right now?

Ober: First of all, we do not try to make bets on an individual sector. We invest in individual stocks. Consequently, the sector weightings are a function of the ideas our analysts come up with and what we determine is appropriate for the portfolio. At of the end of March, technology was 17% of the portfolio, partly because some of our holdings have declined. We have made some sales and some new investments. Financial stocks did particularly well in the first quarter and consequently are now 18.4% of the assets in the fund, higher than the technology group. In all cases, we believe the long-term outlook for the portfolio is a good one. We think stocks such as Oracle and Cisco, for instance, will recover and resume their high growth histories.

Scott: We picked Adams Express because you are one of the leaders in the industry. ADX is also the largest holding in Closed-End Fund Advisors. The two funds, ADX and PEO, are examples of how a new investor to the world of closed-end funds can get started. They are part of a small group of funds founded before the Depression which set the standard for investors who want to get back to the basics.

I have been specializing in investing in closed-end funds for over 20 years now and have found that, once the investor understands how they work, there are many good choices. These web sites, a more responsible press and books published on the industry all contribute to raising the standards for the average investor. If you are an investor who has the desire and patience to build your wealth slowly and want to hold onto what you have, closed-end funds could well be for you. There are over 5000 mutual funds, and, we hope, this interview has helped to show some of the advantages of closed-end funds in showing possible higher returns in an investment that has variety, lower expenses and the ability to buy them at a discount. We strongly feel they are the best way to invest in the stock market. After many years of observing all kinds of investments, we find the best closed-end funds are managed by people who put their shareholders first, usually own a significant stake in their funds and take a long-term horizon towards investing. Your funds fit the bill. Thank you for your time, Doug, and keep up the good work

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