Discount Days for Closed-End Funds

08/04/2008 12:00 am EST

Focus: FUNDS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says some closed-end funds are trading at their deepest discounts in years.

Wall Street has exhibited a lot of “anomalous” behavior lately. That’s a nice way of saying the markets have been acting downright strange. Fear has knocked all sorts of traditional financial patterns out of whack.

One segment of the fund universe looks ripe for a rebound. Closed-end funds issue a fixed number of shares, which are then listed for trading on the New York Stock Exchange or other stock exchanges. Since (unlike a standard mutual fund) a closed-end fund doesn’t continuously issue and redeem shares, the price of the fund’s shares can fluctuate above or below the value of the securities in the fund’s portfolio, also known as “net asset value,” or NAV.

What makes closed-end funds so tempting at the moment? Well, discounts have widened in some cases, to their widest point in years. It’s not unusual to discover well-managed funds quoted at a discount of 10%, 12% and even 15% (or more) to NAV. In other words, you can buy $1.00 worth of assets for as little as 85 cents, perhaps less. When the stock market regains its composure, you’ll be poised to capture double-barreled profits.

Here are two of my favorite closed-end funds right now:

With the explosive run-up in energy prices over the past year, you might imagine that Wall Street couldn’t get enough of specialty funds like Blackrock Global Energy & Resources (NYSE: BGR).

Truth is, however, fearful investors have been dumping BGR, too, despite the fund’s strong track record (up 123% at NAV in the three years ended June 30th). Result: BGR is trading at a yawning 15% discount to NAV. The fund also pays monthly dividends, working out to a 4.7% annualized yield.

Kayne Anderson Energy Total Return Fund (NYSE: KYE) [is] a closed-end fund that invests in master limited partnerships (mostly pipelines) and Canadian oil and gas royalty trusts. By owning these energy assets through a fund, you greatly simplify your tax reporting. Also, a fund eliminates the possibility that you might have to pay tax on partnership income earned inside your IRA or other tax-sheltered retirement plan.

Lately, KYE’s discount [to NAV] has ballooned as high as 13%. As a consequence, the fund is yielding a lush 8% (quarterly distributions). If oil and gas prices were to crash, KYE might have to trim its dividend. But frankly, I think the odds of such an event are quite small.

For retirees and other income seekers, KYE is one of the safer ways to boost your paycheck in a world where “high yield” too often means unacceptable risk.

Buy BGR at $36 or less (it closed above $31 Friday—Editor) if you’re looking for a low-risk vehicle to increase your exposure to oil and gas stocks and KYE at $28.60 or less. (It closed below $27.)

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