The closed-end fund advantage
Catching a rising market is exhilarating. Outperforming the broad averages provides an even greater rush. Accomplishing that task, without taking on extra risk, is the icing on the cake.
GuruFocus readers know I was bullish back on Jan. 10, just a day before this year’s first real bottom was made. They read my optimistic article regarding the full year back on Jan. 17, when almost nobody was thinking positively about stocks.Â
We now know that the market’s final nadir was hit on Feb. 11. A major recovery has taken place since then. During the seven weeks stretching from Feb. 12 through April 1, the S&P 500 ETF (SPY, Financial) regained 11.39%, adjusted for a $1.05 cash distribution (ex-dividend on March 18 and payable April 29).
Just being “in the market” has paid off well with holding cash reserves, while awaiting and trying to sidestep “the next 2008” turned out to be counterproductive.
I made the case for owning small and micro-cap stocks rather than the largest names last weekend. I've also suggested using closed-end funds, now selling at much larger than typical discounts, to play that idea.
Many people contacted me asking for further information about closed-end funds. That prompted me to pen this article.
Closed-end funds, like most other stocks, trade on a supply and demand basis rather than as a strict function of net asset value. Shrinkage in a fund’s discount acts just like a P/E expansion for an industrial company’s shares. It multiplies the effect of changes in underlying value.
Barron’s tracks the overall movement of closed-end funds in every issue. Their Market Week section charts both the changes in values and the variations in discounts of the closed-end universe as represented by the Herzfeld Closed-End Average.
It's easy to see how they badly they got crunched during the sell-offs and how well they've rebounded versus the DJIA since.
Here is documentation of how the Royce Micro-Cap Trust (RMT, Financial) and the Royce Value Trust (RVT, Financial) looked as of Feb. 12 in terms of their NAVs and market prices. At that moment you could buy their already heavily marked-down portfolios for 82 to 83 cents on the dollar.
Both funds paid dividends since Feb. 12. RMT’s owners collected 17 cents per share, while RVT paid out 26 cents per share. Both payments arrived on March 24. The total return figures shown later on have taken those amounts into account.
The combination of NAV gains along with narrowed discounts led to a significant outperformance factor over the past seven weeks.
RMT net asset value gained 14.59%, but its shareholders reaped 17.65% total returns. RVT posted a 16.04% rise in asset value, accompanied with a 19.32% market-based total return.
In those seven weeks RMT’s excess return, compared with the SPY, was 54.96% (17.65% versus 11.39%). RVT’s was even better, at 69.62% (19.32% versus 11.39%).
All three major indices (DJIA, S&P 500 and Nasdaq) have now reached marginally positive territory for the trailing 12 months ended April 1.
I much prefer holding the two Royce closed-end funds, which are still sitting significantly below their year-ago levels. Their negative trailing-year numbers mainly reflect their larger-than-normal discounts to NAV.
Smaller companies and value-oriented firms both recently concluded multi-year periods when they were quite out of favor. It appears we’re in the early stages of a swing back towards both categories.
RMT and RVT remain my favorite ways to play this entire segment without incurring selection risk. It’s not too late to buy either one, or both, of these well-established and conservatively managed funds.
Disclosure: Long RMT, long RVT.
