Smart Money Eyes Undervalued Closed-End Funds

12/10/2018 5:00 am EST

Focus: FUNDS

Michael Foster

Editor, BNK Invest

Despite the panicky headlines, remember that American growth remains strong. That's how the smart money sees things now, counsels Michael Foster, editor of CEF Insider, which specializes in closed-end funds.

With that in mind, your next step will be to do exactly what these savvy folks are doing: buy great investments from the "dumb money" for a song, as they sell in a panic.

That's easy to do with CEFs. For instance, look at the PCM Fund (PCM), a PIMCO-managed bond and bond-derivative fund that yields a shocking 9.5%.

While this fund's underlying portfolio (called its net asset value, or NAV) has posted a 5.1% total return since the start of the year (far ahead of the S&P 500's 1%), its market price has fallen 6%!

chart 1

Despite the fund's underlying portfolio beating the market, the dumb money is selling this thing off like it's a big loser. It's not.

And since housing is a main focus of PCM, through mortgage-backed securities, it's easy to understand why investors are making this mistake: one recency bias error on top of another.

They're overselling due to the recent market crash, which they think will continue, since it's the most recent trend. Plus, they're overselling because they think the next panic will be the same as the last one, although that's never how corrections work.

PCM isn't the only speculative CEF to play a market correction. A similar trend can be seen in the BlackRock Floating Rate Income Trust (BGT), with a market-beating NAV performance that's been "rewarded" with a market selloff:

chart 2

You can see the same thing with the Nuveen Senior Income Fund (NSL), which has both a positive NAV return and a negative price return, thanks to irrational panic over its floating-rate-loan focus:

chart 3

The biggest takeaway is that funds like PCM, BGT, and NSL are great short-term opportunities to buy when the market has oversold them to wait for when market sentiment turns and investors jump in-creating great short-term trading opportunities.

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