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Use This Easy Trick to Beat the Downturn and Own Great Stocks at a Big Discount

Posted
8/18/2011 1:00:00 PM
By: David Sterman
Referenced Stocks:BIF;BTF;JNJ;UTF;WMT

Back in the fall of 2008, virtually every equity-focused mutual fund was falling in value. The selloff was most keenly felt in many closed-end funds (CEFs). Not only did these funds see their portfolio of investments drop in value, but the fund price dropped even more, well below the Net Asset Value ( NAV ) of those fallen holdings. Of course, the subsequent market rebound that began in the spring of 2009 saw the flip side of that trade. Not only did these funds benefit from a rebound in the value of their holdings, but the funds closed that discount by catching up to the (rising) NAV.

We at StreetAuthority have written about this phenomenon several times before. Most recently, Amy Calistri told you how she locked in an 8.7%yield -- and made a double digit gain -- in a matter of days. [Amy brings great ideas like this to her Daily Paycheck readers each month.]

Well, it's happened again. The market swoon that began on July 22 has pushed many closed-end funds lower, down to a level that is well below their (reduced) NAV. As the market snaps back, these funds can benefit from both a portfolio rebound, and a closing of the NAV gap. Here are five closed-end funds that are trading at hefty discounts to NAV, all of which could outperform the pack when the market rebounds.

1. Boulder Growth & Income (NYSE: BIF )
Discount to NAV : -21%

This fund is a no-brainer. Roughly one-quarter of its value ($55 million) is tied up in Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) , and another $40 million is held in Johnson & Johnson (NYSE: JNJ ) , Wal-Mart (NYSE: WMT ) and Cohen & Steers Infrastructure Fund (NYSE: UTF ) . Along with those collective $95 million stakes, another $86 million is tied up in a range of other U.S. blue chip stocks. The fund has a total of $181 in solid investments, yet the fund is valued at just $143 million. This is like getting $38 million in quality stocks for free. Looked at another way, the fund's holdings could lose 20% of their value and still be worth more than the share price of this closed-end fund. Morningstar gives a five-star rating, likely due to the fund's conservative approach to investing.

2. Boulder Total Return Fund (NYSE: BTF )
Discount to NAV: -21.5%

This sister fund to the one noted above takes an even more concentrated approach to blue chips: Berkshire Hathaway, Yum Brands (NYSE: YUM ) , Walmart and JNJ account for more than 70% of assets. The key difference can be found in dividend policies. The Boulder Growth Income fund has temporarily suspended its dividend but may look to reinstate it when the market improves, whereas the Total Return Fund solely aims to garner as much capital appreciation as possible.

3. Gabelli Healthcare & Wellness Trust (NYSE: GRX )
Discount to NAV: -19%

This fund has only been around since 2007 but has generated positive returns every year since -- nomean feat when you consider the market rout of 2008. In fact, the fund saw its NAV rise a hefty 31% in the 12 months ended June 30, but the market pullback in late July put an end to this, and NAV has slumped anew in recent sessions to a recent $8.24. This is well above the fund's recent price of $6.70. The fund's holdings are evenly split among consumer defensive stocks and traditional healthcare stocks.

To be sure, this fund has always traded at a wide discount to NAV, and is due for more attention from Mario Gabelli's eponymous firm. The firm could look to use excess capital to buy backshares of the fund while they remain so cheap, or they could liquidate the while fund and investors would score a quick 19% return (selling costs notwithstanding).

4. Thai Fund (NYSE: TTF )    
Discount to NAV: -17%

Looking to invest in Thailand? Yeah, I hadn't given it much thought either. Investor attention has been focused elsewhere in Asia, in countries like China, Indonesia and Vietnam. But anyone who has visited the region will tell you that Thailand has built out an impressive infrastructure and is increasingly an export base for many multinational firms, especially in the auto industry. Thailand had recently been dogged by domestic infighting that scared off tourists and foreign investors, but a recently-elected prime minster appears to have brought stability.

This four-star ranked fund, run by Morgan Stanley, focuses on large, established Thai blue chip firms, most notably in consumer cyclical, financial services, real estate and industrials. Exposure to fast-growing emerging markets is essential in a time when Japan, Europe and the United States are facing limited long-term growth prospects, making this an ideal holding.

5. Royce Value Trust (NYSE: RVT )    
Discount to NAV: -17.5%

If you're looking for exposure to small caps and micro-caps, then Royce is your best bet. This firm has a team of analysts that continually uncover value in areas of the market where few others tread. The Royce Value Trust is a favorite of the analysts at Morningstar: "There is little we don't like about this fund. It has a well-regarded portfolio manager , sponsor firm, and investment approach. We also find it to be highly shareholder-friendly, as best exemplified by its management-fee structure."

Those words are cold comfort for investors that held the fund while the market was slumping, as small caps and micro-caps took it especially hard. Shares had been trading above the $15 mark all spring, but have since plunged closer to $12. This is handily below the $14.64 NAV.

Small doesn't mean risky for Royce. The holdings in this fund are well-established firms that simply lack the heft to be considered mid-caps or large-caps. One quibble: the fund has stakes in 521 separate companies, which is probably more than necessary to garner a truly diversified portfolio (by about 490 or so). At least this helps avoid blow-ups from any one stock. If you think micro-cap and small-cap stocks will rebound, then this fund will give you extra leverage in order to close the gap.

Risk to Consider: The NAV gaps for these funds may take a while to close, and they may yet fall a bit further, but they provide added upside over the long haul, especially if any of them get liquidated by the sponsor.

Action to Take --> This strategy of buying CEFs at a discount is a tried-and-true strategy that could pay off substantially when the market rebounds. And as my friend Amy Calistri mentioned recently, websites like CEFConnect.com and Morningstar are good resources for finding funds trading at a discount. Any of the funds I mention above are worth consideration by investors.


-- David Sterman

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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.