Trading Overseas With Closed-End Funds

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Karim Rahemtulla, Investment U Research

NEW YORK ( TheStreet) -- Having recently made trips to places like Egypt, Vietnam, Cambodia and Thailand, I have received a lot of questions about the best way to invest in these countries. ETFs are obviously one successful and popular way to make money off the growth of these markets. But I wanted to give you a few other ideas that can help you capitalize abroad.

Without a doubt, investing locally is the best strategy. This allows direct participation in companies that suit your investment goals and profiles. But, it's just not going to be that easy for Americans to call up a broker and ask to buy shares of Telecom Cambodia, when it lists in Phnom Penh later this year.

There are a couple of solutions. The first is to open an account in Asia, Singapore, or Hong Kong with a local broker. Similar to platforms in the United States, foreign platforms allow you to buy and sell shares of companies that trade on regional exchanges in their respective currencies. This would be the ideal strategy.

But, in my experience, I have noticed that Americans tend to prefer keeping their money here and trading through U.S.-based brokers. Bluntly speaking, investors here are for the most part scared to transfer money to some broker 10,000 miles away. Too bad.

To counter this phobia, three investment vehicles have been created in the past 30 years. The first and earliest creation was open-end mutual funds. These funds are essentially like any other mutual fund. They contain investments hand picked by fund managers who you then pay via fees to run your money along with monies of other shareholders. Prices of the funds are posted after the close of the market.

The second vehicle was the closed-end fund. These funds are similar to mutual funds in that they contain a basket of investments. How they differ is that these funds issue shares, which the investor buys on the open market, during market hours. You can buy or sell the shares at any time during the day.

The fund's net asset value (NAV) is calculated in the same way that open-end funds are calculated. Basically the manager figures out the value of the fund's holdings at the close of business and divides that number by the number of shares outstanding. However, the NAV of the fund is never the same as the price at which the closed-end fund trades. The discrepancy is referred to as either a discount or a premium. This is where the fun begins.

Because closed-end fund shares trade in real time on the market and because there are a fixed number of shares outstanding, the funds trade much like stocks in the short term -- based on the whims of buyers and sellers and based on the supply and demand of shares traded at any given time.

This means that a possibility for inefficiency in price exists and that's one of the few inefficiencies on Wall Street today. The key here is to find out what the NAV is from the funds' web site and compare that to the current trading price.

At times, especially during panics or when a country is out of favor, it's possible to pick up the funds at a discount of between 20% and 50% to NAV. That's like getting a dollar's worth of shares for 50 cents or even 80 cents, something that's not possible with an open-end fund or ETF, the third investment vehicle.

ETFs trade a basket of shares based on their real time prices on foreign exchanges. The prices are much more of an accurate reflection of the actual prices hence they offer little chance of picking up a "deal." Remember, closed-end funds don't just hold stocks, but many different instruments, which may be inaccurately priced during a panic. Whereas, ETF's primarily own shares.

In my experience, the time to buy closed-end funds on countries like Thailand, China, or Malaysia and even Russia, Brazil, or India is when the share price is trading at a discount of 25% or more to the NAV. So, the next time you see a panic in an emerging market, head straight to the closed-end funds and check out the bargains you can sink your teeth into.

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