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Closed-End Funds Back On Sale

Tax-loss selling has pushed discounts to historic levels.

If you missed the end-of-summer sale in August, don't worry -- closed-end funds are back in the bargain bin.

Year-end tax-loss selling has pushed prices of closed-end funds to historically wide discounts to the value of their holdings, allowing you to pick up assets from stocks to municipal bonds for as little as 86 cents on the dollar.

Unlike open-end mutual funds, which issue and redeem shares upon request from investors at net asset value, closed-end funds issue a fixed number of shares. They trade on an exchange, like stocks, so the only way you can unload them is by selling them to another investor.

When their investment strategies fall out of favor, they can trade at steep discounts to NAV -- meaning whoever wants out has to leave some money on the table.

This gives other investors the opportunity to pick them up on the cheap. For instance, if a fund's net asset value was $10, per share but its shares traded at $9.50, you could buy the entire portfolio at 95 cents on the dollar.

It's not unusual for discounts on closed-end funds to widen at year's end as investors sell them to harvest tax losses, just as they might sell losing stocks.

Discounts are particularly steep this time around because the industry had a rough summer. Some funds were unloaded by hedge funds that had taken losses related to subprime mortgages and needed to sell other, more liquid assets to raise cash.

Others, like municipal bond funds, were sold off due to concerns about the securities they held.

It didn't help that a large number of new closed-end funds were launched during the year.

Discounts on closed-end funds narrowed in September as bargain hunters stepped in, only to widen again as the year drew to a close.

The market turmoil, combined with a busy period of IPOs, created "a perfect storm for heavy year-end tax-loss selling," says Mariana Bush, closed-end fund and ETF analyst at Wachovia Securities.

She says currently the average discount among all U.S.-traded closed-end funds is 9.9%, more than twice the 4.0% mean over the last decade.

Morgan Stanley issued a report last week saying the historically wide discounts are "attractive buying opportunities."

The report reads like a 24-page spread from


in the Daily News. And some of the discounts, which range from 6.6% to a whopping 13.8%, are as big as those on Macy's racks.

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These discounts are pushing yields on some funds to enticing levels. For example, on Dec. 31 the

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Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG) traded at a 12% discount to its NAV per share, for a yield of 11.4%.

That's nearly triple Friday's 3.9% yield on the 10-year U.S. Treasury note, and fourtimes the 2.2% that the Merrill Lynch Master II High Yield Index returned in 2007.

The index, which measures the yield of the junk-bond market, rose 11.8% in 2006, a yield similar to what the Eaton Vance fund now offers.

Paul Mazzilli, Morgan Stanley's director of ETF research and the report's lead author, says 12% discounts are fairly unusual, and that for most funds the floor is about 15%. That's where professional investors typically step in.

The Eaton Vance Fund is an option income fund, a kind of covered-call fund. It generates additional income by selling call options, or rights to buy stocks at a predetermined price. This income can help offset declines, although it can also limit a fund's upside.

Other option income funds that Morgan Stanley likes include the


Nuveen Global Value Opportunities Fund (JGV), which traded at a 7.4% discount as of Dec. 31, but yielded 9.3%, and the

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NFJ Dividend, Interest & Premium Strategy Fund (NFJ), which posted a discount of 6.6% and a yield of 9.0% at year's end.

"Among equities, the oversold closed-end funds are the option income funds, that is where people are taking tax losses," says Mazzilli. "Meanwhile, fear and misunderstanding about what is going on in the guarantees for municipal bond funds is causing the selling there."

Among closed-end municipal bond funds, Morgan Stanley recommends the

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Van Kampen Advantage Municipal Income Trust II (VKI), which was yielding 5.8% as of Friday's close on a discount around 9.7%; the

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BlackRock Muni Intermediate Duration Fund (MUI) with a yield of 5.5% on a discount of 11.3%; and the

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Blackrock MuniYield Florida Fund (MYF), discount of approximately 11.7% yielded 5.4%.

Among taxable bonds, both Mazzilli and Wachovia's Bush like the

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Van Kampen Dynamic Credit Opportunities Funds (VTA), which was discounted 12.2% to record a yield of 11.3% as of Dec. 31

Wachovia's Bush says if investors want to take advantage of the discounts and capture these yields they have to hurry: discounts had already started to narrow last week. She says the Claymore Closed-End Fund Index bottomed out on Dec. 19.

"The people who didn't take a vacation took advantage of these prices during the last week of December," says Bush. "Now more people are coming back and taking advantage of the heavy tax-loss selling."