Royce, BlackRock Sell at Discount Prices

BOSTON (TheStreet) -- Famed fund manager Charles Royce and bond-investing powerhouse BlackRock (BLK) are giving rare discounts this holiday season.

Closed-end funds including the Royce Value Trust ( RVT) and BlackRock Credit Allocation Income Trust IV ( BTZ) offer discounts of as high as 16%. The discount is the gap between the funds' price and their net asset value -- the worth of the underlying assets. If the difference between the two disappears, investors pocket the difference.

Closed-end funds are popular for investors chasing high yields, especially during times of low interest rates like today. For instance, Bill Gross has managed the Pimco High Income ( PHK), which has a distribution rate of 11%.

Maury Fertig, chief investment officer at Relative Value Partners, a registered investment adviser in Northbrook, Ill., with more than $500 million in assets, says several closed-end funds sport attractive yields, though it's now getting harder to identify bargains. As the Federal Reserve earlier this month stated its intention to keep rates low, investors were given an incentive to seek out fatter yields and dividends.

"The real desire for yield in the last few years has pushed the average bond fund up to net asset value," Fertig says. "The bargains were there for a long time, but they've gone away. There are still a few equity funds that are most interesting. The biggest values remain in the equity world."

Relative Value Partners' niche is closed-end funds and exchange traded funds. Often the best opportunities are found when looking at the discount to the net asset value of a fund, or NAV.

Fertig's first goal is to help investors understand the benefit of closed-end funds. Rather than chasing the higher yields, he wants investors to understand that they have to go to the secondary market to buy and sell shares of the fund, so the manager doesn't have to deal with redemptions.

Second, managers can goose the returns of a fund because they are able to employ leverage. The yield curve is so steep, Fertig says, that the cost of borrowing is cheap. That may work in a stable or improving market, although it proved to be an unwise move during the collapse in late 2008 and early 2009.

Fertig's most important lesson, though, is for investors to understand that the best closed-end fund bargains are to be had when they are priced lower than their historic discounts. That means avoiding funds trading at a premium, like the Pimco High Income Fund, he says.

"You're paying $1.40 for $1 in assets," he says. "People will see Pimco High Income yielding 11% without knowing it's trading at a premium. This has an NAV of $9 and it trades at $13. The risk is that all of a sudden, something precipitates retail selling of the high-yield market. You don't have a safety net."

Instead, Fertig examines funds that have broken down for one reason or another by comparing the market price to the net asset value. "We look for places where we think will be an opportunity or catalyst that will get rid of that discount," he says. "That's the principle reason we play in closed-end funds."

To narrow the search for value more, investors should look at the historical returns of the NAV. When a return to the norm is expected, value is found, Fertig says.

This investment theme is not without risks. Fertig says the biggest risk is buying a fund with a great discount without looking at the underlying assets. "It's possible to have some bad assets or the underlying fees are insane," he says.

Read on to see three closed-end funds Fertig recommends to investors that are trading at an above-average discount to net asset value on a historical basis.

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Royce Value Trust ( RVT)

Managed By: Charles Royce since 1986

Net Asset Value: $15.47

Current Discount: 15.7%

One-Year Price Performance: 28%

Fertig's Take: "The fund has consistently over time beaten the Russell small-cap indices, which they are trying to outperform. So you're dealing with a competent manager who can manage money in this space," Fertig says.

"If you look at this fund over the last 10 years, the discount has been about 3%. So why is it trading at a 15% discount? In the wake of the 2008 and early 2009 equity selloff, this portfolio had a lot of realized losses. They were carrying around a big capital loss carry forward, which put it in a difficult position of suspending the dividend. It was paying a dividend around 8% per year. Once they got in a capital loss position, they weren't able to pay out the dividend," he adds.

"We looked at the most recent filings where they are in a position now where they have eaten through all of those capital loss carry forwards and in 2012 they'll be in a position to reinstate the dividend. That'll be a nice catalyst for some of that discount to go away," Fertig adds. "You have to take the premise that you want to own some mid- and small-cap stocks. What a better way to do it where you have the ability to get Chuck Royce's performance plus this possible 10% dividend over time. That would be pretty powerful."

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BlackRock Credit Allocation Income Trust IV ( BTZ)

Managed By: John Burger since 2006

Net Asset Value: $14.23

Current Discount: 11.5%

One-Year Price Performance: 15%

Fertig's Take: "The average bond fund is trading at NAV. But this is an interesting one. This fund used to be a preferred equity fund when it came out a few years ago. In the wake of the 2008 selloff, BlackRock decided that the fund would be better situated as a bond fund rather than a hybrid," Fertig says.

"They changed the name early in 2010 and they've made it a multi-sector bond fund. It owns some government bonds, mortgage bonds, investment-grade bonds and high-yield bonds. It has a whole mish-mash of different fixed-income assets. They're allocating based on where they see the best value in those sectors," he adds.

"Because of the fact that it was a preferred equity fund, it has a confused investor base. They cut the dividend as well earlier this year. But it still yields 7.5%. This has a longer duration. It's a longer fixed-income play. But it has a nice deep-value story because of the discount associated with it. There's no specific catalyst to get rid of the discount, other than if rates continue to stay low, the market will gravitate towards something like this," Fertig says.

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NFJ Dividend, Interest and Premium Strategy Fund ( NFJ)

Managed By: Ben Fischer since 2005

Net Asset Value: $18.79

Current Discount: 16.3%

One-Year Price Performance: 12%

Fertig's Take: "This fund does two things. It owns convertible bonds, which historically have exhibited half the volatility of the S&P 500 while outperforming it over the last decade. The other part of it contains a covering-call strategy, which is somewhat of a defensive equity strategy. They write call options slightly out of the money to generate income. The portfolio doesn't go up or down as much as the market, but in a sideways market, it can do rather well," Fertig says.

"But with the market off 37% in 2008, funds like this had their net asset values hammered. They weren't generating enough income in the portfolio, so they slashed the dividend by about 70%. That triggered an avalanche of retail selling. To give you a sense of how irrational some of the trading was, it was trading around $13 before they cut the dividend in 2009. It was yielding about 12% and they cut it to where it was yielding about 4%. In a few weeks, the fund traded below $10. That's a 30% selloff," Fertig adds.

"In this case, this fund has been trading at an average discount of a few percent. It was trading at a 25% discount in the panic. Subsequent to that, the market came back, and the fund has come back. The story here is that the underlying portfolio has done well in this recovery. They're now in the position where they can potentially raise this dividend. But this fund today is still at a 15% discount, which we find incredible for something like this," he says.

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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