Two Fund Opportunities

05/10/2010 1:00 pm EST

Focus: ETFS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann and Jack Colombo, publisher and editor of Forbes/ISA Closed-End Fund & ETF Report, like technology and income in funds that trade like stocks.

The market has been looking shaky of late, with wide intra-day swings. The unsettled market may be at an inflection point, but its direction is still unclear. Facing this uncertainty, the natural inclination is to find a security that might weather the storm or take advantage of an upswing.

The best bargains we have come across are closed-end funds (CEFs) trading at a discount. The question of which one offers the best buy had been answered by a newly issued ETF. The answer is to buy all of them.

The PowerShares CEF Income Composite ETF (NYSE: PCEF) is an oddity. It’s the first ETF that invests in closed-end funds. The fund uses a rules-based approach that invests in three classes of CEFs: those that invest in taxable fixed income, high-yield fixed income and option income. Each CEF must have an expense ratio lower than 2% and meet certain size and transparency requirements.

The fund invests proportionally more assets in funds trading at deep discounts. It pays dividends monthly and is likely to average about 8%. The fund rebalances its portfolios quarterly to take advantage of fund trading at deeper discounts and selling funds that have higher premiums.

It also has the advantage of not being solely interest-rate-dependent because of its exposure to equity income through covered call funds. The intra-day NAV can be checked on Google Finance with the ticker symbol PCEF.IV. (PowerShares CEF Income closed Friday above $24—Editor)

The recent earnings report from Intel (Nasdaq: INTC) augurs well for the tech sector. Microsoft (Nasdaq: MSFT) reported that Windows 7, their new operating system, was gaining widespread acceptance, in stark contrast to the Vista operating system that was widely panned by critics.

When a new operating system gains acceptance, it usually spurs consumers to upgrade their systems and starts a new technology replacement cycle benefiting the entire sector. We scouted a number of tech funds and settled on one. 

The Seligman Premium Technology Growth Fund closed-end fund (NYSE: STK) invests in the technology sector and also provides some income by writing index call options on the Nasdaq 100. The fund yields 9.4% and pays quarterly. Best of all, it trades at a discount to net asset value of [about 5%].

It debuted in November 2009, so there is not a one-year average discount available; however its average premium since inception is about 2.09%. The fund started out with an NAV of $19.06 and [closed Friday above $18—Editor].

The fund is invested in software at 46.7% and computers and peripherals at 14.7%, followed by communications equipment at 9.5%. It does not use leverage and invests exclusively in US stocks. Its largest holding is Synopsys (Nasdaq: SNPS), representing 7.3% of its portfolio.

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