Two Funds That Control Risk

11/17/2010 2:00 pm EST

Focus: FUNDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, publisher of the Forbes/ISA Closed End Fund & ETF Report, recommends a discounted play on Warren Buffett and a natural resources fund with a generous yield.

The market appears to be sequencing through a “risk on”/ “risk off” cycle, [alternating] between low-riskTreasuries and higher-risk small-cap stocks. A middle ground might be [found in] Warren Buffett-type securities, usually large-cap stocks with good and consistent growth prospects. There is a fund [that] invests in these securities and trades at a significant discount to its net asset value.

The Boulder Total Return Fund (NYSE: BTF) invests in a limited number of securities, but takes large positions in them. One of the largest holdings is Berkshire Hathaway (NYSE: BRK.B) stock, [with] almost 40% of [the fund’s] assets invested in it. Since the fund trades at an 18% discount, it is an excellent way to participate in the gains of Warren Buffett's investments, but at discounted price. The fund [closed Tuesday at around] $15.50.

The fund previously attempted to deal with the high discount by using a managed distribution policy, but when this didn’t work, they abandoned the idea and now rely on capital gains only with no payouts. They use leverage, which [recently was] at 23.92% of their portfolio. They are 92% invested in equities, with the rest in cash equivalents. They are mostly invested in the US market, with 89%, [followed by] Hong Kong at 4.91%. After Berkshire Hathaway, their largest holding is Yum! Brands (NYSE: YUM) at 16.51%.

We think the increasing discount levels of buy-write funds are a function of the “risk on” psychology. [Buy-write funds generate additional income by selling call options on their holdings—Editor.] Since buy-writes minimize risk through the option-writing mechanism, they do best in flat to slightly appreciating or depreciating markets and do the least well in sharply rising markets. These are good investment vehicles to hold, since they produce income regardless of market direction.

The BlackRock Real Asset Equity Trust (NYSE: BCF) is a closed-end fund that invests in real assets such as energy, natural resources, and basic materials. It [closed Tuesday] at $13.30 and yields 8.17%. The fund currently trades [at a 1% discount to its net asset value] and does not use leverage. Metals and mining stocks make up 43.3% of the portfolio, followed by oil, gas, & consumables at 28%.

The trend in the international arena is a rise in real asset values as different economies race to devalue their currencies. About half of the [fund’s] holdings are non-US-based, [led by] Canada at 12.7% [and] followed by the UK at 11.4%. Its largest holding is in BHP Billiton (NYSE: BHP) at 3.8%.

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