Buying Closed-End Discounts

07/19/2013 8:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

This exchange-traded fund buys closed-end funds that are trading at a discount to their net asset values, notes income expert Richard Lehmann in the Forbes/ISA Closed End Fund & ETF Report.

The closed-end universe reacts to market declines with a slingshot effect. As their underlying assets drop in price because of market forces, their share price drops even more than the net asset value.

Thus, if the NAV drops from a dollar to ninety cents, the price of the fund may drop from a dollar to eighty cents. This slingshot effect occurs because investors want out of the underlying securities so they sell the closed-end funds.

Since closed-end funds trade only on supply/demand, the increased selling causes them to trade at larger discounts. The bottom line is that they become good buys in bad times.

It’s difficult to pick out which of the funds will react better than most in a rising interest rate market. However, one fund buys the deepest discount funds that have ample liquidity.

The PowerShares CEF Income Composite ETF (PCEF) buys discounted closed-end income funds in a mix of different types of funds. The fund invests in three broad classes of closed end funds; fixed income funds, high-yield fixed income and covered call option funds.

The collective discount of the individual closed end funds held are at -6.71%. The 52-week average of its individual holdings is -3.68% below the collective NAV.

The ETF itself trades very close to its own NAV; the market price has not traded from the NAV more than 0.5% for the year.

Ex-dividend date is between the 17th and 19th of each month. It currently holds 43.17% in bond funds, 17.33% in high yield funds and 35.77% in option income funds.

The fund will rebalance at the end of the month adding five new funds and selling one. The fund currently trades at $24.74, has an indicated yield of 7.99% and pays monthly.

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