A little-followed area of the capital market could now present big opportunities for investors.
Closed-end funds are mutual funds that trade like stocks — making them similar to exchange-traded funds. However, closed-end funds tend to be actively managed, while ETFs tend to passively track an index. That means the closed-end funds are theoretically designed to generate outperformance (though the fees tend to be higher as a result).
Another difference is that the transparency and market structure of ETFs make arbitrage possible, which consequently means that ETFs trade very much in line with the value of their holdings. Closed-end funds, on the other hand, may trade at steep premiums or discounts to their net asset values — a phenomenon that has been referred to as the closed-end fund puzzle.
In the current environment, several funds are trading at especially deep discounts to the net asset values, which is bad news for current investors but might pose an interesting chance for those looking to buy.
"[There are] huge discounts, some of the most significant discounts we've seen since the global financial crisis back in '09," said Maury Fertig, chief investment officer of Relative Value Partners, which invests client money in closed-end funds. "You name different sources of volatility in the marketplace. ... China or commodity prices or Greece have all contributed to more selling. ... That's really led to where we are now."
Fertig's favorite picks are three funds trading at deep discounts: Eaton Vance Limited Duration Income, currently at a 14 percent discount to net asset value, Tri-Continental Corporation, trading at a 16 percent discount, and MFS Charter Income, at a 14 percent discount.
Provided that investors actually want to own everything contained in the fund, they are effectively paying 85 cents to get a dollar.
Of course, such investments are not without risk.
"You have some funds which have consistently been underperformers, whether it's a bad manager, whether it's very high fees, whether it's an asset class that's way too risky to own," Fertig said Thursday on CNBC's "Trading Nation." "You have to look at the underlying asset class and make sure you're buying into a sector that you fundamentally want to invest in."
Consequently, Fertig would stay away from other funds trading at even deeper discounts, like the MS Emerging Market Domestic Fund, which opened Friday at $7.51 and enjoys a net asset value of $9.09.
Disclosures: Fertig's Relative Value Partners own Eaton Vance Limited Duration Income, Tri-Continental Corporation and MFS Charter Income for clients and principals.
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