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Closed-End Bargains Hard to Find

Shrinking median discounts mean you'll have to dig deeper into the closed-end bargain bin.

Bargains in closed-end funds continue to erode like a snowman in a spring rainstorm.

In March, shares of closed-end funds covered by Lipper traded at a median discount of 2.34% to net asset value, the lowest level in 12 months. That level marked a 0.86 percentage-point decline from the end of February.

During the one-year period ended March 31, the combined discount on closed-end funds declined by 4.29 percentage points.

Whereas open-end mutual funds continually issue and redeem shares at their net asset value, closed-end funds release a fixed number of shares and are traded like stocks. Therefore, the market, not its holdings, sets the price of shares in the funds.

Prices in a trendy sector often sell at a premium over net asset value. Likewise, when investors sour on a fund's investment style, the share price can fall beneath the value of its holdings.

The past 12 months have seen a steady decline, mainly due to investors looking for yields from securities. Investors paying $8 a share for a fund trading at a 20% discount are purchasing $10 worth of equity or bond holdings, leading to a higher yield.

When discounts narrow, people are less interested in buying into tight discount areas.

"People are looking for that yield, that kicker to get the benefits," says Tom Roseen, a senior research analyst at Lipper. "Investors have really changed their mindset from late 1999 and 2000, when it was 'Income? Who cares? Capital gain, capital appreciation.' And we learned a good lesson in the

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subsequent market decline that we need both sides of the equation, both capital appreciation and income distribution."

The median discount on closed-end bond funds narrowed 0.92 percentage points to 2.34% for the month. For the previous month, median discounts on those fixed-income funds had widened to 3.26% from 2.68% in January.

Discounts on equity closed-end funds tracked by Lipper narrowed 0.72 percentage points in March, the second-narrowest monthly median discount for that fund classification in the past 12 months. Domestic equity funds offered the lowest median discount of any Lipper class, finishing the month at a 0.97% discount, a major reduction from 2.21% in February.

The only group that saw widened median discounts -- World Equity Funds -- grew an eye-popping 181 basis points to 7.49%. Funds in that classification "saw a kind of minimeltdown," Roseen says.

"People got a little bit scared by the China Syndrome," he adds, referring to the Chinese market tumble at the end of February.

Most funds enjoyed improvements in price compared with net asset value. Individual discounts narrowed, premiums increased or premiums replaced discounts for 64% of all closed-end funds tracked by Lipper in March (71% of fixed income funds and 51% of equity funds).

"Discounts don't have a lot more room to narrow," Roseen says. Future levels are "going to be very market-dependent. People aren't going to buy up these closed-end funds if they expect the market to start tanking. I don't think we're there yet; even though the unemployment rate is down, new jobs are declining, and people are on the fence right now."

For the month, 36% of all closed-end funds traded at a premium, up from 30% in both January and February.