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Income Looks Attractive

10/01/2008 1:00 pm EST

Focus: FUNDS

Neil George

Editor, Profitable Investing

Neil George recommends several closed-end funds to weather these volatile times.

The best place to start building your portfolio continues to be our favorite collection of closed-end bond funds, including AllianceBernstein Global High Income (NYSE: AWF), BlackRock Income Opportunity (NYSE: BNA), (NYSE: RCS), PIMCO Strategic Global GovernmentTempleton Emerging Markets Income (NYSE: TEI), and Western Asset Emerging Markets Floating Rate (NYSE: EFL).

The funds hold government bonds issued by the US as well as other governments around the world. The US government continues to pile on debt, and other governments are diversifying their reserve holdings to include more than just US Treasuries.

The funds also hold high-quality corporate bonds issued by US and global corporations. The mix includes fixed- and floating-rate bonds, meaning we get the base and security of the locked-in fixed yields as well as the inflation-protection of bonds that reset their interest or yield rates based on various indexes. The higher the rates, the higher the interest you’re paid.

Granted, the ratings agencies—Moody’s, Standard & Poor’s, and Fitchhave lost a lot of their credibility based on their participation with pooled debt such as collateralized debt obligations, the focal point of the crisis afflicting global financial markets. But they’re still relevant when it comes to governments and many large-scale corporations.

The net asset value (NAV) for each of our closed-end funds is reported on an ongoing basis, weekly, monthly or quarterly. And it’s a simple process to estimate NAV on a daily basis: taking the portfolio holdings and run prices for them in the real market.

The real question is whether the funds are being priced by the stock market at a premium or discount to NAV. Ideally, you’d want to buy more of the funds trading at a discount, less of the funds trading at a premium.

But don’t shun a fund just because it trades at a premium. NAVs are estimates and tend to trail underlying asset values. The funds disclose holdings on a trailing basis, and NAVs catch up afterward, until the next filing.

In bullish markets, prices tend to head higher, so that real NAVs for these funds tend to be understated. And some holdings aren’t as easy to price in real time, including some of the synthetic investments used to streamline investments to reduce cost to us while boosting returns.

One example is PIMCO Strategic Global Government which holds individual bonds but also has a series of derived security investments to gain the benefits of some government bonds without having to deal directly—often at higher transaction costs. Its NAV can be understated depending on the exact timing of the posting of the holdings and their stated values.

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