Two Good Niche Closed-Ends

04/12/2010 11:00 am EST

Focus: FUNDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, publisher of Forbes/ISA Closed End Funds & ETF Report, and editor Jack Colombo find closed-end funds that provide entrée to two attractive niche markets.

The biotechnology sector, as represented by the First Trust AMEX Biotechnology ETF (NYSEArca: FBT), is a new and intriguing entry into [our] top performers’ list. The biotech field is one dominated by [Food and Drug Administration] decisions, at least for new drugs. An adverse ruling can devastate a stock, and positive rulings can double its price, but it’s impossible to predict which will occur.

That makes a fund holding a number of biotech stocks the ideal vehicle for investing in this sector. The ups and downs tend to average out and give the investor the best chance to participate in this relatively new field. The passage of the health care bill may reduce uncertainty in the sector and lead to better stock performance. The First Trust AMEX Biotechnology ETF is one such fund, but why buy this ETF at its net asset value when you can buy essentially the same stocks at a –17.42% discount? 

The H&Q Life Sciences Investors closed-end fund (NYSE: HQL) invests in biotechnology, medical devices, and pharmaceuticals. The fund invests in smaller emerging companies and can invest 40% of its assets in restricted stock of public and private companies. The fund management believes this approach allows investors to participate in this hard-to-access portion of the health care market.

The fund currently trades at $10.69 and has a net asset value of $12.52, giving it a discount of –14.62%. The fund is invested in 44% biotechnology, 29% in health care, and 11% in pharmaceuticals.

It also invests about 10% of assets in income producing convertible securities. In addition to small emerging companies, Celgene (Nasdaq: CELG) and Amgen (Nasdaq: AMGN) are two of its largest holdings. The current discount is close to the fund's average one-year discount of minus 19.28%. (HQL closed Friday at 10.69—Editor.) 

The threat of inflation to the markets will likely prompt an increase in interest rates. The rise will hit income securities as their prices decline to reflect new and higher interest rates.

To protect against this rise, floating- rate funds buy adjustable-rate debt that increase along with prevailing interest rates. Most of the closed-end funds that invest in these securities are trading at hefty premiums of around 10%, but we found one that trades at a small premium of less than 1%. 

Nuveen Tax-Advantaged Floating Rate CEF (AMEX: JFP) currently trades at a 0.917% premium to net asset value. At such a low price, the difference between the bid and ask price can significantly change the discount/premium calculation.

On March 19th, the fund announced changes to its investment policy including the not so insignificant one of suspending management fees effective March 1, 2010. The fund is not leveraged, pays a respectable 8.22% yield, and pays dividends monthly. JFP has traditionally bought short-term preferreds, but [it will now] buy longer maturities, which will increase the rate of return in coming months. (JFP closed Friday at $2.50.—Editor)

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