They are a rarity on themarket today.
Most of the headlines over the summer have been about how
thestock market is nearing all-time highs... making it difficult
for investors to find a good entry point for manystocks .
But that could be changing. In August, the S&P 500 fell
about 4.5%, while the Dow Jones Industrial Average fell 5.4%.
Could thebull market we've experienced over the past few years
be coming to an end? It's entirely possible. As I reported last
week, it all has to do with the looming Bernanke
bond bubble burst
or what I'm calling the "October surprise."
But a slow down, or a completeturnaround in the stock market,
should not be looked at as a bad thing. It should be viewed as an
What if there was a way to invest just 90 cents and get a full
dollar's worth of interest-earning power? In other words, what if
we could easily buy stocks discounted by 10% or more and boost
thedividend yield we collect from them at the same time?
There is a way we can do that. But first, let me explain how
we got to this point...
For the past few years, interest rates have been tilted in the
borrower's favor, which has allowed companies to borrowcash
cheaply and use it to quickly expand. But short-term interest
rate hikes could throw a wrench into the works.
This isn't just a distant threat. Rates have already shot
higher in recent weeks as traders prepare for a new reality
without quantitative intervention from the Federal Reserve.
With historically low interest rates, the playing field is
still tilted in the borrower's favor, but it's much tougher for
companies to grow than it was just a few months ago. Andasset
prices have fallen accordingly.
But as stocks fall, there are some that go too low -- to the
point of becoming bargains. And one of the easiest ways to find
stocks that are trading as bargains is to look at closed-endfunds
Closed-end funds are simplymutual funds that hold stocks.
Unlike open-end mutual funds, which most people hold in their
401(k) andoffer as manyshares as investors are willing to buy,
closed-end funds carry a fixed amount of shares that investors
can purchase on the market.
I could go through every detail, but basically because
closed-end funds can't increase their share count, theirmarket
value can fluctuate and be much different than their "net asset
value " (NAV ), which represents how much the holdings are
And if closed-end funds should sell off along with the rest of
the market, it couldmean we have an opportunity to buy a basket
of quality stocks at discounts of 5%, 10% or more compared with
what they're really worth.
Let me give you a real-life example to explain.
Zweig Fund (
. It's a closed-endfund that has $340 million innet assets ,
which are invested in a diverse basket of blue-chip stocks such
as PepsiCo, Apple, JPMorgan, Comcast, U.S. Bancorp and
With 22.8 millionshares outstanding , each share of the fund
is worth $14.93 (according to the NAV). But here's the good part:
You don't have to pay full price. ZF shares have dipped deep
below NAV, so you can get $14.93 worth of dividend-paying stocks
for just $13.00.
That means we can essentially buy shares in each of those
quality companies at a 13% discount. If you bought this fund
today, you'd pay just $424 for each share of Apple it holds --
which last traded around $487 per share on the market. You get
the same 13% discount for all the other stocks held in the fund,
Not to mention you get to collect thedividend income from
those stocks. But because you paid less for your shares, you're
effectively getting higher yields. So instead of collecting a
2.5%yield from Apple, you're getting 2.87% ($12.20 per share
dividend on $424 shares = 2.87% yield).
Now, that doesn't automatically make ZF a buy. If for no other
reason, overall total returns have been lackluster over the long
With that in mind, I conducted a screen for funds with lofty
5%-plus yields, noleverage (and no exposure to rising rates) and
double-digit discounts to NAV. I also looked for funds with
superior performance whose trailing three-year returns outrun
their respective benchmarks.
Here's what I found:
The advantages of buying an income-paying fund at a
double-digit discount are obvious, particularly when the stocks
orbonds inside that portfolio are themselvesundervalued .
If a quality fund that typically trades at a slight 1% to 2%
discount suddenly slides to a 10% discount in a broad market
pullback, there's an opportunity. There's usually a reversion to
the mean. But don't automatically assume that a discounted
fundwill close the NAV gap -- some stayunderwater for years,
always showing somewhat of a discount. That's why it's more
instructive to compare a fund's current discount with its
But this list is a good starting point to conduct more
research on whether one of these funds would make a
goodinvestment . And if Bernanke & Co. do indeed decide to
taperthe Fed 's bond purchasing program and the market takes a
hit, which is very likely, these funds will be some of the
firstinvestments I'll look at to buy on a pullback.
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