Closed-End Funds Offer the Best Bargains

If market turmoil continues, look for steep discounts to NAV.
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Keep your eye on closed-end funds.

If this week's market turmoil turns into something more serious, that's where some of the best opportunities may spring up.

Even better, they might be opportunities that even a conservative investor could jump on with a reasonable margin of safety.

We're not there yet, however. This week's market plunge came as no surprise to anyone who has been following the fund-management world closely. As reported here in mid-February, there were plenty of warning signs for emerging markets and for stock markets in general. Fund managers were way too bullish.

If the shakeout wasn't a total shock, neither was the meager "rally" that followed. Big money managers were simply out of bullets. As was also reported here two weeks ago, cash balances had fallen toward record lows.

There are plenty of reasons to think the turbulence may continue. Among them is the obvious point that there are almost bound to be some "semi-pro" hedge fund managers somewhere who got into trouble. They will be forced sellers of shares, and then the managers will go back to the jobs they held before -- selling Jacuzzis, probably.

Half-hidden behind the news about the market was some bad economic news as well. The key figure from Wednesday's house-price survey was this: The number of new homes that have been completed but are still unsold has jumped 47% from this time last year.

Forty-seven percent.

There are some very shrewd people who think the markets, and the U.S. economy, are in trouble. The milk bottle is certainly wobbling. If it tips over, be ready. That's when you get to lap it up.

It may not happen. We're not there yet.

Closed-end funds are a great place to look because in any kind of market rout you can end up getting a double discount. That's like going to Filene's Basement and getting an extra saving at the till.

What are closed-end funds? They are regulated, professionally-managed investment vehicles -- like mutual funds, but with one big difference. Whereas an ordinary mutual fund issues new units whenever people invest more money, closed-end funds issue a set number of units, usually when they are first set up, and that's it. People who want to put money in or take it out buy and sell the fund's shares, as they would shares in a company, on the stock market.

Closed-end funds come in a wide variety. Some invest in U.S. blue chips. Some invest in bonds. Others invest in emerging markets. The special quirk of closed-end funds is that the price of the share you buy or sell in the market may not actually correspond with the value of the investments the fund holds. If lots of people want to get out of the fund at the same time, the share price can drop well below the fund's intrinsic value.You can often buy a share for 90 cents that gives you the claim on $1 worth of investments.

Which is what can happen in a panic.

An example right now: the $394 million

Clough Global Equity Fund

(GLQ) - Get Report

, run by Chuck Clough. He was a Merrill Lynch strategist until a few years ago, when he left to start his own shop. He runs private-money and hedge funds as well as three closed-end funds for ordinary investors.

Clough Global Equity invests in stocks worldwide. It gives Clough the freedom to put the money where he sees the best opportunities, and to avoid what he thinks are needless risks. It has done well since it was launched in April 2005. The underlying investments had turned a 32% profit through the end of 2006, compared with around 27% for the

S&P 500

index. That's even after paying steep management fees of 2.5% of the assets per year.

Clough Global Equity's investment record looks less good to casual observers because when it was launched, the shares were priced at about 5% above the value of the underlying holdings. That's where the salesmen, at companies such as

Merrill Lynch


, make their cut.

On Friday, though, Clough Global Equity shares had slumped to 9.5% below net asset value. That was based on Thursday's close.

That discount, which had been widening since the start of the year, yawned significantly this week during the turmoil. You're now paying less than 91 cents for each dollar of investment. The forecast dividend yield is a wonderful 6.6%.

One caveat is that most closed-end funds, including Clough Global Equity, borrow against their holdings. If interest rates were to skyrocket, that would certainly squeeze investment performance and dividends. On the other hand, if the market were to tank, the chances of a further rise in interest rates would be minimal.

Clough Global Equity is a diversified and well-run fund. Its top holdings range from reinsurance companies such as

Partner Re


Monpelier Re




(GOOG) - Get Report


News Corp.

(NWS) - Get Report

and Japan's

Daiwa Securities


To put it bluntly, the risks of investing in this market right now surely have to outweigh the potential rewards. Global stock markets are not cheap. This week's fall shaves a minuscule fraction off the massive price inflation we've seen in the past nine months. Closed-end funds can offer a discount to net asset value, but they are not without risks of their own. Sometimes the best investment advice is the dullest: Keep your powder dry.

In keeping with TSC's editorial policy, Brett Arends doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Arends takes a critical look inside mutual funds and the personal finance industry in a twice-weekly column that ranges from investment advice for the general reader to the industry's latest scoop. Prior to joining in 2006, he worked for more than two years at the Boston Herald, where he revived the paper's well-known 'On State Street' finance column and was part of a team that won two SABEW awards in 2005. He had previously written for the Daily Telegraph and Daily Mail newspapers in London, the magazine Private Eye, and for Global Agenda, the official magazine of the World Economic Summit in Davos, Switzerland. Arends has also written a book on sports 'futures' betting.