Exchange-traded funds have recently become the favorites of the fund world. But investors should not forget that closed-end funds can offer the same performance figures, if not better. Ratings uses proprietary quantitative models to generate ratings on approximately 470 closed-end funds and 130 ETFs. Over a number of years, the output from our models has consistently shown that foreign/international funds have been among the top performers in either category. A subset of these foreign funds are the so-called country funds, which are distinguished by their specific focus on a particular country, as opposed to a region.

My pick among the top-ranked closed-end country funds is the Mexico Equity & Income Fund ( MXE - Get Report). Its returns are outstanding: year to date it has achieved 30.26%, over one year it has returned 57.95%, and its three-year record is 45.97%. The fund's sponsor is Phicardo Asset Management, and Gerald Hellerman is its manager.

The fund's top holdings include America Telecolm SA, Cemex ( CX - Get Report) and Empresas ICA ( ICA).

The mystery of closed-end funds is that some discounts that exist between the share price and net asset value (NAV), or the sum of assets minus liabilities in the portfolio, do not narrow irrespective of the fund's performance. MXE is no exception, with the share price of $20.42 trading at a nearly 14% discount to its NAV of $23.73.

Since August 2005, the fund's discount has oscillated between 16% and 9%. The 9% discount was recorded in May 2006, and has since increased to the current 13.3%. Two things in particular may have caused the increase -- the market jitters earlier this year regarding emerging economies and the recent political chaos in Mexico.

The July 2006 presidential election resulted in the center-right candidate Felipe Calderon, of the National Action Party, or PAN, defeating leftist Andres Manuel Lopez Obrador of the Party of the Democratic Revolution, or PRD, by a mere 0.58% of the vote. Citing irregularities at various polling stations, Lopez Obrador appealed the decision and demanded a full recount. But on Tuesday, the Federal Electoral Tribunal declared Calderon president-elect.

The situation is by no means resolved, with Lopez Obrador supporters continuing to block major streets in Mexico City and Lopez Obrador himself vowing to stage further protests, including the potential proclamation of a parallel government. It is not yet clear how much support he will have for continuing his campaign now that Calderon's victory is official.

"Lopez Obrador is not going away and is going to be making noise for the next six years, but he is likely to be less effective as time goes on," says Urban Larson, Latin America portfolio manager at F&C Investments, a European investment firm with approximately $200 billion under management. "Recent polls show that 70% of the public wants Lopez Obrador to stop his civil disobedience campaign."

Larson believes that "there is no chance that Lopez Obrador will succeed in keeping Calderon from taking office. But his movement could undermine the effectiveness of Calderon's administration."

"If Calderon cannot successfully reach out to Lopez Obrador's supporters, especially more moderate factions, then he, like his predecessor, Vicente Fox, will be powerless to seek genuine structural reform and the Mexican economy will effectively be on autopilot," Larson concludes.

Clearly, this is a fluid situation that can, and most likely will, change on a day-to-day basis. For an investor, the key point is to be able to put this situation into perspective. Those who can bear the political risks can view the current price of MXE as an opportunity to get in on this fund as part of a value play.

One final point: The fortunes of the Mexican economy, and those of other North American Free Trade Association economies, are tied in many ways to the U.S. economy. If the U.S. slows, emerging economies such as Mexico may be hit harder than more mature economies.

High Risk, High Reward

Some recent statistics on the Mexican economy show its GDP to be growing at 4.7% year over year, consumer prices increasing at 3.1%, and a jobless rate of 4.0%. These numbers show a healthy economy, and certainly the performance of MXE would back that up.

Mexico Equity & Income has a solid annualized total return of 15.29% since its inception date of Aug. 21, 1990. The fund charges a management fee of 1.82%, which is quite low in comparison to other foreign funds, which tend to have higher management fees than domestic-focused funds.

The fund's objective is to achieve high total return through capital appreciation and current income. The trust invests the majority of its assets in equity and convertible debt securities issued by Mexican companies, and the remainder in debt securities. The allocation to debt instruments is low, accounting for just 2.5% of the portfolio, made up of Mexican government bonds.

In terms of risk, MXE is nondiversified, meaning it can take larger positions in a few companies, which increases its risk profile. A focused strategy such as this can also yield above-normal profits, in line with the general relationship between risk and return. In essence, the higher the risk, the more return investors should expect. The total shares outstanding amount to 2.47 million, which offers a degree of liquidity. However, investors should treat this and other closed-end funds as small-cap companies, meaning that the lower liquidity of its shares contributes to higher risks than would be present in large-cap companies with far greater shares outstanding.

Best of the Rest

The hidden gems in both ETFs and closed-end funds are the so-called country-specific funds. Below are two tables that highlight our top five county funds for both ETFs and closed-end funds.

ETF Country Funds Return/Performance as of Aug. 31, 2006 (%)
Fund Ticker Year to Date One-Year Three-Year Five-Year
iShares MSCI Belgium EWK 20.82% 28.49% 33.52% 18.12%
iShares MSCI Spain EWP 24.74 30.47 27.98 17.39
iShares MSCI France EWQ 20.55 26.36 24.46 10.93
iShares MSCI Italy EWI 19.83 23.58 25.65 13.49
iShares MSCI U.K. EWU 19.16 23.44 22.59 10.43
Average Return 21.02 26.47 26.84 14.07
Source: Ratings

Closed-End Country Funds
Return/performance as of Aug. 31, 2006 (%)
Fund Ticker Year to Date One-Year Three-Year Five-Year Discount (-)/Premium
The New Ireland Fund IRL 24.16% 29.55% 37.92% 21.24% 31.84%
Mexico Fund MXF 19.63 50.07 42.26 25.04 -12.18%
Swiss Helvetia Fund SWZ 20.6 39.47 29.55 17.27 -10.58%
Mexico Equity & Income Fund MXE 30.26 57.95 45.97 26.51 -13.30%
New Germany Fund GF 21.3 28.66 32.99 16.47 -10.66%
Average Return 23.19 41.14 37.74 21.31
Source: Ratings

The table below shows that, on average, the top closed-end country funds have outperformed the top exchange-traded funds with a country focus. The year-to-date comparisons are close, but for the one-, three- and five-year time periods, the difference in performance is stark, with the closed-end funds clearly outperforming the ETFs.

Year to Date One-Year Three-Year Five-Year
Average Return Top Five Closed End Funds 23.19% 41.14% 37.74% 21.31%
Average Return Top Five ETFs 21.02% 26.47% 26.84% 14.07%
Source: Ratings

Sam Patel, CFA, is the manager of mutual fund Research for the Ratings.

In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Patel cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.