In the world of investing, closed-end funds (CEFs) offer distinct opportunities alongside notable challenges. Financial expert Michael Joseph notes that these funds frequently trade at prices that deviate from their intrinsic value. This market inefficiency can benefit discerning investors; however, purchasing a CEF at a discount does not guarantee success.
Joseph warns against targeting CEFs solely based on the largest discounts to their net asset value (NAV) or the most attractive yields, as this strategy can lead to poor investment choices. He advocates for a more nuanced approach to navigating this intricate market.
Understanding the risks of closed-end funds
Investors may hope for an activist investor to rectify pricing discrepancies between a CEF’s market price and its NAV. However, Joseph cautions that this strategy carries significant speculative risks. He highlights a critical lesson learned during the Federal Reserve’s interest rate hikes in, which caused the valuations of several leveraged municipal bond CEFs to plummet by nearly 50%.
Joseph’s book, titled A Dollar for Fifty Cents, serves as a guide for both novice and experienced investors. While the title suggests the potential for easy profits, he emphasizes that the reality is considerably more complex. It also references historical instances, such as when Warren Buffett and Charlie Munger acquired a substantial stake in Source Capital after the market downturn of 1969-1970, with prices nearly 50% below actual asset values. While Buffett and Munger ultimately achieved significant returns, Joseph stresses that such steep discounts are rare.
Strategic approaches to investing in CEFs
Joseph advocates for a strategic approach to engaging with CEFs. His research suggests that purchasing shares when the discount to NAV is approximately 20% and selling when the discount narrows to 15% can be effective. This method allows investors to leverage market fluctuations while reducing the risks associated with deeper discounts.
Tools and resources for informed decisions
One of the book’s strengths lies in its accessibility to a broad audience, including those without extensive financial backgrounds. Joseph summarizes existing research aimed at explaining why CEFs trade below their actual value. He introduces the concept of CEFs with specified termination dates, designed to provide investors with a clear timeline for cashing out at NAV. However, he cautions that these termination dates can often be extended, complicating the investment landscape.
Additionally, Joseph highlights useful tools, such as free screening websites, to assist in selecting appropriate CEFs. He advises caution regarding funds whose names may misrepresent their actual holdings, as well as the misleading distribution rates often found in CEF fact sheets.
Performance and diversification benefits
The subtitle of Joseph’s book, Proven Strategies to Outperform the Market with Closed-End Funds, suggests a promise of superior returns. Although several studies indicate that CEFs can deliver strong performance, readers seeking a comprehensive index-beating management record focused entirely on CEFs may be disappointed. Instead, they learn from Rich Bello, the foreword writer, that his firm has successfully integrated CEFs into its investment strategy.
Many investment professionals agree that closed-end funds can enhance a well-rounded portfolio. They offer diversification benefits, particularly within income-focused strategies that include bonds, preferred stocks, and REITs. CEFs that consistently increase their distribution rates over time can help income-oriented investors preserve their buying power, especially in the face of inflation. Michael Joseph’s balanced analysis provides crucial insights into the advantages and drawbacks of investing in CEFs, equipping readers with the knowledge necessary to make informed decisions.