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Closed-end funds can be purchased at a discount

Timing is everything. Hit the Web site at the right time, and you get tickets to Bruce Springsteen and the E Street Band. Two seconds too late, and you’re watching Bill and the Ankle Biters.

As far as we can tell – you never know what will happen next – the Standard & Poor’s 500-stock index bottomed on March 9. It’s up 34.1 percent since. You may feel you missed a chance to get the biggest bargains.

And you did. But you can still find plenty of bargains. The easiest to find are in closed-end mutual funds.

A closed-end fund is the earliest form of mutual fund and, frankly, they’re relics of a bygone era. They have a structure that was first developed in the 1920s, and has long since been improved upon.

Like all mutual funds, closed-end funds are a professionally managed portfolio of stocks or bonds. And like exchange traded funds, you can buy and sell shares of closed-ends on the stock exchanges.

But unlike all other types of funds, closed-end funds issue a fixed number of shares. New closed-end funds raise money through an initial public offering and use that money to buy and sell stocks and bonds. In this sense, a closed-end fund is a bit like any company that’s listed on the stock exchanges. One way to think of a closed-end fund is as a corporation whose business is buying and selling stocks.

What makes a closed-end fund peculiar is that its share price often doesn’t reflect the value of its holdings.

Let’s consider the Cohen & Steers Worldwide Realty fund, which trades under the ticker RWF. As of Wednesday, the assets in the fund’s portfolio, minus expenses, were worth $4.48 a share. But the fund’s shares sold that day for $3.38 – a 32.5 percent discount, in closed-end parlance. If the fund were liquidated that day, brand-new shareholders would get an instant profit of $1.10 a share.

Most closed-end funds sell at a discount, which has mystified academics for years. One theory is that closed-end funds don’t liquidate very often. And if they were to sell all their holdings at once, they would have to do so at fire-sale prices.

But basically, closed-end funds sell at a discount because the fund’s share price reflects what investors think of the fund’s prospects, not its current value. Shareholders would be right to have a low opinion of Cohen & Steers Worldwide Realty fund. Its shares have plunged 76.9 percent in the previous 12 months, including reinvested dividends, according to Morningstar, the Chicago investment trackers.

Investors are often mistaken, though. As witness to this, a few funds sell for a premium – that is, for more than the value of their holdings. Pimco High Income, for example, sold at $8.59 a share Wednesday, even though the securities in its portfolio were valued at $4.74 a share, an 81.2 percent premium.

As you may have guessed, it’s better to buy at a discount, not a premium. As proof, we looked at the entire universe of closed-end funds and ranked them by their premium or discount five years ago. We then created four groups – group one had the highest premium. Group four had the biggest discounts, and groups two and three were in the middle.

Group one sold for an average premium of 10.9 percent. The funds, which were a mix of stock and bond funds, lost an average 19.6 percent over five years. Group four, the cheapest funds, sold for an average discount of 8.3 percent. Average return: -4.1 percent.

Buying at a steep discount is no guarantee of profits. The Boulder Total Return fund sold for a 15.6 percent discount five years ago, and has since plunged 39 percent. Nevertheless, the universe of deeply discounted closed-end funds is a good place to start hunting for bargains. The Latin America Discovery fund, which sold for a 16.7 percent discount five years ago, has soared 123 percent.

Cecilia Gondor, editor of The Investor’s Guide to Closed-End Funds, says that closed-end fund discounts are still huge, compared with their historical averages. The average discount is about 4 percent; it’s 8 percent now. She favors closed-end municipal bond funds, which currently sport average tax-free yields of 6.4 percent.

Many closed-end muni funds use borrowed money to augment their yields, and that increases risks, too. Be sure to check that before you buy.

For the daring, closed-end real estate funds might be a good place to start. The Cohen & Steers management team is one of the best in its field. For technology buffs, Gabelli Global Multimedia Trust (GGT) is selling at a 25.4 percent discount.

You can find a great deal of information on closed-end funds, including premiums and discounts, at www.closed-endfunds.com, as well as www.morningstar.com. Choose your picks carefully. If you buy a closed-end fund at a discount, you may not have time on your side. But you will have price – and that’s a big advantage.

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