What would you say if someone offered you thousands of dollar bills at .85 cents on the dollar? You would probably be a little wary that the offer is too good to be true, but as many investors know, similar opportunities are commonplace in the mysterious and little-understood world of closed-end mutual funds.
Many of you are probably more familiar with open-end mutual funds, but once you understand what you are getting with closed-end funds or a portfolio of such funds, you may see significant returns.
So what are these funds all about? Unlike open-end mutual funds, a closed-end fund issues a limited number of shares. Once these are sold, the fund is closed and the shares trade like any other share of stock, and like stock, are influenced by the usual market forces. Shares of open-ended funds, by contrast, can only be sold back to the fund.
The proceeds from the sale of a closed-end fund's initial offering are used to buy a portfolio of securities. Those securities can be of a particular sector or country or objective.
Here is the sweet thing about closed-end funds. Their appeal, as a general rule is that their shares tend to sell for less than the total value of their underlying investment portfolio. One caveat though is that this discount usually occurs after all of the fund's shares have been sold and the fund closes.
This so-called discount is a phenomenon that many economists don't fully understand, but it is not a mirage. Closed-end funds sometimes trade at double-digit discounts from their net asset value (value of the portfolio assets divided by the number of shares owned by investors) As a result, it is possible to make (or lose) money not only from price changes in the funds investments, but in changes for the demand for the shares of the fund.
Another difference is that some closed-end funds offer a managed distribution policy, or a promise to pay investors a fixed periodic payment (normally quarterly). Open-end funds are permitted to distribute gains only once per year.
Although in-and-out trading of closed-end funds can produce quick gains, many investors consider them superior to regular mutual funds for the long term. Closed-end funds can offer the chance for a higher dividend payout and overall better returns.
Several factors account for this. Managers of closed-end funds don't have to concern themselves with daily purchases and sales by investors. Not having to keep cash on hand for unexpected redemptions (like when everyone freaks out and sells their shares on geo-political events) means that the managers can be fully invested at all times and keep expenses down.
In a rapidly rising market, a huge pile of cash can drag down overall performance and closed-end funds can be thinly traded, or the underlying portfolio may be full of thinly traded securities that may increase the potential for long-term returns.
To be sure, closed-end funds are not risk free. The biggest stumbling block is often the reason that they are popular in the first place, the discount in price , which can widen in a rapidly falling market.
Believe it or not, a lot of information is available on closed-end funds. For example, they are listed weekly in the Wall Street Journal. You can also obtain information from specialized newsletters, Web sites and of course, me. I have found that closed-end funds can have a place in a client's portfolio, so if you would like them to be a part of yours, I can be contacted at 841-4277.
• Carol Perry, a Northern Nevada resident since 1983, represents the firm of Wachovia Securities in Carson City.