The Disciplined Investor: Pennies on the Dollar

As you pick through the wreckage looking for quality assets being given away, turn your attention to the closed-end fund (CEF) market. The discounts on some funds are so wide now, and the yields so gargantuan, that the CEFs can be described only as absolutely compelling.

A starting point -- and the reason I noticed this opportunity -- is the First Trust Active Dividend Income Fund (FAV - commentary - Cramer's Take). Be aware that my firm sub-advises this fund, but that should not detract from the logic of the analysis.

FAV is an equity-only fund that generates a high level of dividend income, which is then paid out quarterly. Like most long-only funds, FAV's net asset value (NAV) is down substantially with the markets, although it has been outperforming the Russell 1000 Value. Unfortunately, closed-end investors lost confidence in this asset class at an even greater rate than stock investors abandoned the stock market.

The fund is now trading at a 21% discount to net asset value. (At the close Friday, the fund was at a 32% discount. I have updated all numbers as best I can for today's rally.) The fund just declared its next dividend, and is trading at a 21% yield on the current share price.

Now be aware that CEFs have risks. The NAV can decline if the market continues to decline. There is always a chance that dividends are cut. The manager could blunder and create a period of underperformance. There may be no catalyst to ever remove a discount because the assets are usually locked up in the fund forever. So read this analysis with a full understanding of these and other risks.

Any individual fund can possess one or all of these risks, but the fact that you can find so many CEFs trading at substantial discounts indicates that there is a general pall over the asset class. At some point, the discounts on CEFs are likely to narrow. If the stock market is bottoming, these funds can provide a "double dip," growing NAV and reduced discount can create a nice slingshot effect. And you are paid to wait!

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At the time of publication, Dvorchak was long the First Trust Active Dividend Income Fund, although positions can change at any time.

Gary Dvorchak is a managing partner of Aviance Capital Management, a Sarasota, Fla.-based institutional asset manager that manages $200 million in growth and value equities and fixed income. Dvorchak holds a master's degree in business administration from Northwestern University and a bachelor's degree in computer science from the University of Iowa.