If you missed the> brief window two weeks ago when closed-end funds sold at radical discounts, you weren't alone. The $215 billion market makes up just 10% of the mutual fund universe. But investors who follow these products are looking forward to another buying season right around the corner.
Every December, closed-end funds tend to trade at a discount -- shares of the fund are limited (unlike those of an open-end fund), and they sell for less than the value of the underlying investments. Because the bulk of closed-end funds invest in municipal bonds, and investors in these funds tend to be very tax-sensitive, a year-end selling pattern tends to open up buying opportunities between late December and February, says Cecilia Gondor, an executive vice president at Thomas Herzfeld Advisors. Of course, as more investors catch on to this trend, the discounts get less steep, but in the past 10 years, closed-end fund share prices have dropped, on average, 0.74 percentage points between the end of October and the end of December, and then gained an average 2.36 percentage points between year-end and the end of January, according to data from Thomas Herzfeld Advisors.
The selling season could be especially dynamic this year, Gondor says. Investors are already jittery about the value of the municipal bonds that make up many closed-end fund portfolios, making them eager to sell when the time comes. Also, uncertainty about the extension of the Bush-era tax cuts could intensify the year-end selling, although it seems increasingly likely that they ll be extended for most investors, says Tom Roseen, a senior research analyst at Lipper.
And it doesn t take much to create a discount window. These funds typically are not very liquid, so even one or a couple of investors selling out of a position can be enough to move its price. Most closed-end muni funds will trade between a few thousand and 20,000 shares a day, but there are many funds that are less liquid than that, Gondor says. Investors who are concerned about radical price movements should look for funds that tend to trade around 10,000 shares every day, but in this small market, predictions are impossible: One fund saw its price drop by 40% in a week, simply because one large shareholder had died and the estate had liquidated those assets, says Mike Taggart, a closed-end fund strategist with Morningstar.
If you re hoping to pick up a closed-end fund on sale, put in an open order to buy a few shares of a fund or two at a price below the current market price, Gondor says. If that order gets executed, it ll be like an early-warning system that will alert you to a buying opportunity, she says. A word of caution: Never buy anything at a premium, says Maury Fertig, the chief investment officer at Relative Value Partners, a firm that manages more than $500 million in assets and specializes in closed-end funds. It s hard to justify paying more than a dollar for a dollar s worth of assets, and if the market hits a rough patch, funds at a premium have the farthest to fall, Fertig says.
Here are five funds to watch through December:
This $6.6 million fund invests in tech stocks and, at just $1.09 a share, could almost be considered a penny stock itself, Roseen says. It s trading at a 34% discount, a little wider than its three-year average. It s a very focused fund with a less-than-great track record but it s cheap, and holds some strong names, including Apple and Amazon, Roseen says.
Putnam Muni Opportunities
This $724 million municipal bond fund has a distribution rate of 6.87% and is currently trading at a 2.7% discount, narrower than its three-year average of a 7% discount. It s one of the higher-yielding muni funds, and it could be a buy if the discount widens to about 5%, Fertig says.
DWS High Income Opportunities
This $317 million fund just changed strategies it used to be an equity fund but, as of Wednesday, is now focused solely on high-yield bonds, and it s trading at a 6% discount. (The average high-yield bond fund is trading at a premium.) Its current distribution rate is 6.7%, but that could rise because of the new strategy, Fertig says. Management is also authorized to regularly buy back shares, he says, which is good for fund owners.
Nuveen New York Muni Value
This $147 million fund invests entirely in New York municipal bonds with an average duration of less than 5 years. It s not nearly as volatile as some of the other funds, says Ronald Deutsch, the managing director of Sage Capital Management. It s currently trading at between a 2% and 3% discount, close to its historical average, and Deutsch says he s watching for further dips.
Tortoise Energy Infrastructure
This $1.1 billion fund invests in master limited partnerships in the energy infrastructure sector. It s currently trading at more than an 11% premium, higher than its three-year average of 8.65%, and though some would say never to buy at a premium, Deutsch says he d buy in if a year-end dip brings the fund below about a 2% premium.