If you have been a fan of ESPN's "College Game Day" for the last decade or so, you are used to Lee Corso saying "not so fast my friend."
I had this thought as I read my colleague Kevin Baker's
write-up the other day on the
First Trust/Aberdeen Emerging Opportunity Fund (FEO). The Street.com Ratings has initiated coverage of the closed-end fund with an "E," or "very weak," rating, noting that it lost 4.67% over the 12 months through August.
The not-so-fast comes from the fact that the decline cited is actually in the market price of the fund. The fund's net asset value (chart below) actually went up 15.5% over that period.
FEO holds a mix of bonds and stocks: 42% equities, 61% fixed income as of June 30. (Like many closed-end funds, it is slightly leveraged.) For that reason, it makes sense to compare it to both a stock fund like the
iShares MSCI Emerging Markets Fund
and a bond fund like
Templeton Emerging Markets Income Fund (TEI), which has been trading for many years.
As the chart shows, FEO's net asset value has outperformed the bond fund but underperformed the stock ETF.
Part of the reason for the lackluster performance of FEO's share price is that it is a fairly new fund, having just listed in August 2006. Like all new closed-end funds, it listed at a 5% premium to its NAV. The premium represents the sales charge you paid if you bought it through the IPO.
It's not unusual for the initial premium on closed-end funds to erode once they start trading, and many eventually swing to a discount to NAV. Gaming the size of the discount or the timing of this effect is difficult to do, but in 14 months of trading, FEO has gone from almost a 5% premium to NAV to a 15% discount. It is this action that accounts for the weak performance cited by Baker.
But the fund's investment strategy appears to be sensible, and there's a good argument that it is now attractively valued. It seems to be very prudent in terms of spreading risk. The 42% allocated to equities is split among 18 countries, with Brazil being the largest at only 7.4%. No single stock takes up more than 2% of the fund.
On the bond side of the ledger, the fund spreads out among 20 countries, with the largest again being Brazil at 8%. Interestingly, the second-largest bond allocation goes to Ukraine at 6%. I would also note that the bonds are a mix of dollar-denominated and local currency paper. While I have a bearish view on the dollar long term, the U.S. currency's recent uninterrupted descent makes me believe some sort of short-term correction is plausible.
This sort of diversification indicates that the fund's objective is to simply capture fairly representative returns of emerging markets stocks and bonds in a single product, as opposed to making concentrated bets in an effort to shoot the lights out versus its benchmark. In other words, this is a top-down strategy.
Over the last few years, just buying a diversified emerging-market product, without necessarily picking the best-performing country, has been an important way to boost a portfolio's return.
Obviously, the more concentrated bets you take on individual markets or securities, the more risk you take, and FEO seems to do the opposite. This should make the fund less volatile,
in relative terms
Not So Fast, My Friend
Source: Yahoo! Finance
In the mean time, it yields 8%, again trades at a 15% discount and has a hefty 2.07% management fee.
I believe the performance of the fund's NAV means that the managers' strategy does capture the desired effect of blending emerging market stocks and bonds. Future results depend on both the managers' ability to stick to this strategy, and whether the discount to NAV stays where it is, gets larger or starts to shrink.
Assuming FEO's discount stays where it is or shrinks, I believe the fund offers a good way to get exposure to both emerging-market stocks and bonds. I was not able to find any emerging-market closed-end funds trading at bigger discounts, which leads me to conclude that while FEO's discount may not narrow, it is unlikely to widen.
At the time of publication, Nusbaum did not have positions in any of the securities discussed in this article, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
to send him an email.