The recent action in closed-end funds has been so puzzling that it requires a professional code-breaker to decipher it. Luckily, that was Richard Shaker's job before he started managing money.
After retiring as chief of mathematical research for the National Security Agency in 1995, Shaker started
in order to focus his quant skills on trading closed-end funds. Based in Annapolis, Md., Shaker manages more than $60 million in assets, up from $3 million in 1995 and $24 million in 2002.
At the end of March, Shaker's fund had a one-year total return of 23.4%, compared with 11.82% for the
Total Return Index. For the prior three- and five-year periods, Shaker handily beat that index by 7.5 and 10.6 percentage points, respectively.
spoke with Shaker about the recent turbulence in closed-end funds.
TheStreet.com: Lately we have seen a lot of sharp moves in the closed-end world. What is your take on the increased volatility?
: Our strategy is to look for an individual fund that randomly moves above or below its typical discount level. Recently, we have seen entire sectors make a large, quick move in discounts, then just as quickly return to their pre-move levels. This is unusual. I've never seen it occur so dramatically.
For example, we follow 10 funds that write options on their large-cap holdings as their basic strategy. I don't like the strategy and don't like the fact that they trade at very small discounts or premiums.
However, around Feb. 20, all 10 had wider-than-average discounts, with eight of the 10 at a yearly high discount. We bought three of these, and their discounts narrowed on average by almost 5% in three weeks. This was incredible. There was no news we know of to account for either change in sentiment.
A few weeks later, in early March, news of the demise of the carry trade caused an equally dramatic widening of discounts in high-yield bond funds. If the demise of the carry trade really was a problem for high-yield bonds, you might think that the net asset value of high-yield bonds would be severely affected. They did fall a little -- about 1% -- but nothing like the discounts of the CEFs, which widened an average of 4% in a week. Talk about not discounting twice!
One week later, when it became clear that the reports of the death of the carry trade were exaggerated, NAVs regained all their losses and discounts recovered more than half of their losses. There were similar -- but not so sharp -- moves down and up the next two weeks, but what was again most striking was that the discounts of most all these funds moved in lock step.
Those gyrations took place in March, but now you are saying that April and May were among the wildest months you have ever seen in closed-end fund trading. Would you elaborate?
As your closed-end fund viewers probably know, closed-end fund discounts have narrowed significantly during the last couple of years, with the
of all funds actually moving to a premium for the first time in fourth-quarter 2006. It tacked on almost 500 more basis points of premium in the first four months of this year.
The most dramatic event to spark that was Art Lipson's victory over
. Lipson took a 3% stake a bit over a year ago, lost two elections, but caused so much trouble that the fund capitulated to his demands and will seek approval for 11% of NAV managed distribution.
For a closed-end fund as old and as large as TriContinental to be successfully attacked by an activist came as a big surprise to the closed-end funds community. It was comparable to what mathematicians thought when Fermat's theorem was proved. Many other large U.S. domestic funds narrowed in sympathy, the idea being that if TriContinental could be successfully forced to be shareholder-friendly, others might be as well.
But the TriContinental move was rational, if a bit overdone. Others have been harder to rationalize.
Which funds in particular have been erratic?
We used to enjoy trading
between a 6% discount and an 8% discount, but over a three-month period it moved to a small premium and now seems to be trading in a new range between a slight discount and a small premium. That move, exaggerated and without cause, was at least deliberate.
Mexico Equity Fund
has also been wild. It traded as high as a 17% premium a few days ago, now it is at a smaller but still very significant premium. The preferred, which has features that should cause it to trade at a higher value than the common but is hurt by lack of liquidity, trades at a small discount or small premium, still more than 10% higher relative to net asset value than last year.
To get exposure to Mexico, it makes sense to instead buy
, which is depressed due to a recent rights offering, at a 12 to 14% discount. For disclosure purposes, we have been buying MXF in recent days although our largest holding remains the MXE preferred.
First Israel Fund
, presumably reacting to a Jonathan Hoenig plug on a financial TV show, in two days early this month went from its typical 8% discount to an unheard-of 12% premium, topped out at a 14% premium on the third day and has now settled back to a small discount.
There are many other stories like this, perhaps not as wild as these, but wild nonetheless.
Can you give us an example of an exciting recent trade?
One of the best opportunities we have had for a quick turnaround trade this year occurred on May Day, with
New Germany Fund
, a closed-end fund that invests primarily in German mid-cap stocks. Its discount had narrowed from 9% to 7% prior to a 2% distribution that went ex on May 1.
On May 1, New Germany opened slightly lower and then, for no reason at all, plunged 6%. Although we might have expected the discount to widen back to 9% after the distribution, there was little or no change in the market or the net asset value of the fund to account for such a big selloff.
These quick dumps, which happen to many closed-end funds, often give you little opportunity to buy in quantity. However, on that particular day the stock traded over 100,000 shares down between 5% and 6% for an hour or so, and for the rest of the day it was still possible to pick it up at down between 2% and 4% until near the close, when New Germany recovered all of its losses. It's still holding a 7% discount. We have sold most of the shares we bought on Mayday but still have a few to dispose of.
Nicely done. What funds are you buying now?
Calamos Total Return Fund
is usually one of the lowest discounted high-yield dividend funds at around a 3% or 4% discount. Nevertheless, it is currently one of the highest ones at an 8.5% discount. We've been accumulating that one.
Any country funds? Those are always popular closed-end fund plays.
We like both of the India funds:
Morgan Stanley India Investment Fund
. Even though the Indian markets seem tired, these two funds, which traded at big premiums a year ago, now sport double-digit discounts and seem to be bargains.
, which used to trade at a premium and can now be bought at an intraday discount of 7%. We've been trading it, even though throughout its trading range it has intermediate-term value.
We've been buying
New Ireland Fund
at a 6% discount. This stock is always a wild one, typically swinging between a 5% discount and a 5% premium.
Recently, we've also been trading
( MF), and we've thought
has been a good buy for several weeks.
Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.