The Closed-End Fund Analysis Trifecta, Part 3: Net Asset Value Performance

This is the third installment of a three-part series covering closed end funds.  This content was produced by John Cole Scott, CFS at Closed End Fund Advisors.

3. Net Asset Value Performance

A closed-end fund is best described as three things:

1. A near permanent number of shares without daily in/out flows (open-end funds) or the involvement of creation units (exchange-traded funds).

2. Active portfolio management involving portfolio managers and a team of analysts  vs. a passive index or a pre-determined formula.

3. Investor liquidity or the ability daily to have the shares trade on a US exchange (NYSE/ NASDAQ).

While all CEF shareholders buy and sell at market prices on exchanges, we find it best to track a portfolio manager and their team using NAV performance. This takes their cost into account vs. the investments that they purchase or sell over time. Even though there are funds with large differences in how the market price trades vs. the NAV movement, as we track with 90 day NAV / Mkt Price correlation figures, we have noticed that over the long-term a CEF’s market price eventually follows its NAV trend and should be monitored closely.

NAV Performance - Rules of Thumb

• We suggest investors look at a CEF’s NAV performance and compare it to its peer-funds and a tracking index. This is a great way to confirm the fund is a good investment vs. discount or dividend hype driving the market price.
• CEFA doesn’t dwell on expense ratios, as we feel, growing capital from its current level is far more important than a 0.25% (only an example) difference in friction on the portfolio. NAV calculations take out the fund’s operating and management costs in order to compare funds on a net basis.
• We do not completely ignore expense ratios, but it is a secondary factor in our CEF research process.  

Conclusion: While there are many factors to consider, we feel if you can get a handle on these three main concepts (Entry Point Risk, Dividend Risk and NAV Performance) you are likely to have more success in a CEF oriented portfolio vs. the masses. Remember with CEFs you only need to be faster and smarter than the average individual investor or financial advisor, as it is hard for the billion dollar blocks of capital to use CEFs due to liquidity concerns. As of our November 8 weekly data, 72.8% of CEF trade average daily liquidity of $250K to $2.5MM.

According to the Investment Company Institute’s (ICI) 2011 data, only 1.8% of US households own shares in closed-end funds. We believe this fact alone should give serious, disciplined investors or investment professionals a reason to learn more about CEFs and how to understand their risks and benefits. Armed with this knowledge, you have the opportunity to find above normal yield and performance.

A closed-end fund is a structure around an investment objective. While CEFs can be inefficient and under-utilized, we believe they provide great opportunity for investors. However, they are not a magical formula to avoid risk and performance loss. Also, as data on funds or their peers is updated regularly, they are not considered by our firm to be the best buy-and-hold investment vehicles. Swapping funds in a CEF based portfolio should be considered a normal part your portfolio management process.

• Part 1: Entry Point Risk - The NAV vs. Market Price for a CEF
• Part 2: Dividend Risk/Security