Money for Nothin' and the Bonds for Free

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If someone offered to sell you a $1 bill for $0.87, would you do it?  Unless you’re simply terrible at math (or for some reason you don’t like money), the answer should be a resounding yes, of course.  But why even bother asking such a ridiculous question?  Economics 101 teaches us that it is not rational for anyone to sell $1 for $0.87.

Or would they? Right now, that is exactly what a buyer of the Templeton Global Income Fund (GIM) gets: $1 of assets for $0.87.  How can this be? What’s the catch?  And what do you really get for your $0.87?  This article will answer all of those questions while also shedding a little light on a dark corner of the market where great bargains often hide.

The Templeton Global Income Fund is a closed-end mutual fund that invests in sovereign debt issued by governments from around the world.  It is managed by Dr. Michael Hasenstab, who also manages the far better known Templeton Global Bond Fund (TGBAX) and who was named Fixed Income Manager of the Decade by Morningstar for his management performance during the 2000s.  Dr. Hasenstab follows a nearly identical strategy for the two funds, searching for attractively priced government debt issued by countries with sound economic and financial fundamentals while using a currency and derivative overlay to increase returns and reduce risk.

The fund currently pays an impressive annual distribution of 5.14% (paid monthly) without using any leverage and while using swaps to negate interest rate risk (duration currently sits at 0.76).  Given the positioning of the underlying assets, Hasenstab is expecting future interest rate increases.  Clearly there is much to like about the strategy, especially for investors looking for high current yield in a rising interest rate environment.

“But wait,” you say. “If the two funds managed by Dr. Hasenstab use effectively the same strategy, then why bother with this closed-end one that no one has ever heard of?  And what’s all this fuss about $0.87?”

Great questions.  Let’s talk about closed-end funds.

Closed-end mutual funds are poorly-understood and largely neglected by most market participants.  They are overshadowed by their far larger and better understood open-end cousins and therefore receive scant attention from investors.  However, just as with stocks that are not widely followed by analysts, the lack of attention paid to closed-end funds can sometimes lead to great value opportunities. 

So exactly what is a closed-end mutual fund?  It is a sort of hybrid security that shares characteristics with both open-end mutual funds and individual stocks.  Like a stock, a closed-end fund raises a set amount of capital through an IPO by issuing a fixed number of shares.  However, unlike a stock, a closed-end fund uses this capital to purchase a pool of actively-managed securities that are typically focused on a specific industry, geography, or sector, in much the same way as an open-end fund does.

The shares of closed-end funds then trade throughout the day on an exchange, just like stocks.  Their prices fluctuate depending upon supply and demand in the market, rather than the value of the underlying assets held in the fund.  It is this unique structure that can allow for some very interesting bargains, as the price of a closed-end fund in the market can deviate significantly from the value of its assets due to a number of factors. 

You might be thinking, “Wait a minute.  ETFs also trade like stocks, but their prices don’t seem to deviate from the value of their underlying assets.  What gives?”  The answer is transparency.  ETFs are highly transparent; investors can determine the exact holdings of an ETF at any time, meaning that any deviations of price from asset value would immediately be eliminated by arbitrageurs.

The same is not true for closed-end funds.  Holdings in closed-end funds are actively-managed and are only disclosed periodically – usually just one time per month or per quarter.  At any given point in time, investors have no way of determining exactly what a closed-end fund holds.

As a result, sentiment surrounding certain sectors, geographies, or strategies can drive demand up or down for certain closed-end funds, leading to (sometimes large) deviations in price away from the fund’s net asset value.

So how does this concept apply in the case of GIM, and how can investors take advantage of it?  There is no sure way to determine exactly what drives demand for GIM at any given point in time.  It is likely a combination of factors, including recent changes in price and net asset value (NAV), performance and flows into and out of the Templeton Global Bond Fund (the open-ended version of GIM), sentiment regarding the health of foreign and emerging markets, and a number of other factors.

Taken together, these factors can cause demand for GIM to be greater than or less than the supply of shares in the market.  From the middle of 2009 to the middle of 2013, demand for GIM consistently outstripped supply, causing the fund to trade at a premium to its NAV (the premium reached a maximum of 11.5% in August of 2011).

However, beginning in the second half of 2013, demand for GIM dropped below supply, and these dynamics have remained in place for the past five years.  Accordingly, GIM has traded at a discount to its net asset value over this period and currently trades at a -12.9% discount.

In essence, buyers of GIM currently get $1 worth of assets for a price of only $0.87.  In my opinion, that’s quite a deal for a fixed income strategy with minimal interest rate risk, modest credit risk, a healthy cash distribution, and one of the best bond managers in the world at the helm.

Given Dr. Hasenstab’s impressive track record and the soundness of his global bond strategy, I feel confident in his ability to continue to generate attractive returns for investors in both the open-end and closed-end funds going forward.  But investors in GIM could benefit further if sentiment improves and the price of the fund converges with the value of its assets.

It isn’t often that one gets offered a dollar for 87 cents, but in this low-yield, high-uncertainty market environment, I believe savvy investors should take the market up on its offer and buy the Templeton Global Income Fund before the bargain disappears.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas , Bonds
Referenced Symbols: GIM

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Matthew Blume, CFA

Matthew Blume, CFA

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