Equity analysts can render opinions about a stock being overvalued or undervalued. But stocks don’t necessarily trade at prices analysts think are fair value. They trade at the market price. Market makers set a bid and an ask, and you can’t buy securities at a discount to what sellers are willing to accept.
Unless you buy a basket of securities in a closed-end fund. Closed-end funds can trade at a premium or discount to the market value of their underlying assets. For example, a closed-end fund that holds a portfolio of stocks worth $500 million might trade for $400 million – a 20% discount.
Yes, it is possible to find funds that trade at discounts that high. When you buy shares in the fund, you effectively get to buy its underlying holdings at a 20% discount. You get more bang for your buck in terms of any income distributions. (Closed-end funds may hold stocks, bonds, real estate investment trusts, master limited partnerships, or other assets). And if the fund liquidates or starts trading on par with its net asset value, then you stand to reap the appreciation.
The following table shows the ten closed-end funds trading at the deepest discounts, as of this writing. We excluded any funds with market capitalizations of less than $100 million.
Closed-end funds purchased at opportune times – ideally when they’re trading at an unusually large discount – give you superior risk/reward characteristics compared to other ways of investing. Yet virtually nobody on Wall Street talks about how ordinary investors can exploit the opportunities in closed-end funds. You never hear CNBC talk about them. Perhaps that’s because closed-end funds are dwarfed by mutual funds, ETFs, and hedge funds in terms of total size.
Investing in closed-end funds requires a bit more due diligence than investing in ordinary index funds. Some closed-end instruments specialize in obscure asset classes. Others may employ leverage or other higher-risk strategies. And just as some trade at enticing discounts, others trade at unjustifiable premiums.
Only when a closed-end fund’s portfolio construction and management style squares with your investing objectives should you consider owning it. You may find that a closed-end fund that trades at a discount meets your objectives just as well as a similar product that doesn’t.