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Closed-End Funds Feel Twice the Pain

Richard Widows

Last week's worldwide stock market implosion hit closed-end mutual funds particularly hard.

Many suffered a one-two punch as their shares sold off even faster than those of their holdings.

As a result, not only have their net asset values fallen, their shares are trading at even bigger discounts to NAV than they were at the end of the previous week.

Unlike open-end funds, which continuously issue and redeem shares at their net asset values, closed-end funds issue a fixed number of shares.

The only way to get out is to sell the shares to another investor, and when everyone is headed for the door at the same time, they have to be willing to leave something behind.

To identify the closed-end funds that fared the worst from these combined effects of dwindling asset values and widening discounts, TheStreet.com Ratings searched its database for those meeting the following criteria:

• Decline of more than 6% in market price during the week ended March 2.
• Discount of market price relative to net asset value per share of at least 3% on March 2.
• Deterioration of the premium/discount ratio of more than 2 percentage points during the week.

Not surprisingly, closed-end funds that invest in China experienced some of the sharpest deteriorations in the value of their shares relative to that of their NAV.

At the top of the list is the (CGH Quote)Greater China Fund (CGH); its shares fell 14.51%, and its discount to NAV widened by 6.77 percentage points, to 9.45% from 2.68%.

Of the 23 funds we identified, 13 were Asian-focused, with four specifically targeting China. And all but one of the funds on the list have an international focus.

That represented a big reversal, given how high international stocks, and Chinese stocks in particular, had been riding. In the three months ended Jan. 31, five of the funds on our list traded at premiums to their NAV, on average. Interestingly, however, the valuations of these five funds already had swung to a discount to NAV by Feb. 23 -- a possible signal that investors were starting to get nervous about their lofty valuations even before the Shanghai stock market stumbled last week.

While only the (CHN Quote)China Fund (CHN) started last week with a discount to NAV of more than 10%, nine of the funds on the list had discounts in the double digits at the end of the week's carnage.

In fact, the only fund on the list that started last week trading at a premium to its NAV was the (IRL Quote)New Ireland Fund (IRL), which was worth 4.16% more than the value of its holdings at the start of trading on Feb. 28. By the closing bell on March 2, it had swung to a discount to NAV of 3.28%, a trend its shareholders dearly hope will be reversed by St. Patrick's Day.

As Brett Arends noted last week in his column "Closed-End Funds Offer the Best Bargains," funds that get hit by a combination of falling asset values and widening discounts to NAV when the markets sell off also have the potential for an accelerated recovery when markets rebound. That's because investors can benefit from both an increase in net asset value and a narrowing of discounts to NAV.

While this may sound tempting, investors should beware that share prices of closed-end funds can persist at levels below their NAVs for maddeningly long stretches of time. Of the 521 closed-end funds we tracked at the end of January, 383 of them, or 74%, traded at average prices that were below their respective NAVs over that period. So even though these funds appear to be bargains, it may be years before this strategy pays off.