Monday, 30 July 2012

Closed End Funds: July 2012 High Discounts - Anything Worth Buying?

Last week we looked back at the most heavily discounted Closed End Funds of December 2008 to see how things turned out. Most of those big discounters made investors a lot of money though a minority lost big. This week, let's scan the current list of CEFs with the biggest discounts, again using the Globe and Mail's Closed End Fund report to find and sort the funds. We've taken a screen snapshot of the result and post it below.

R Split III Corp (TSX symbol: RBS) 45.8% discount of shares to Net Asset Value (NAV)
The largest apparent discount of all is a data error. The Globe's NAV figure is the sum of the capital share (RBS) plus the preferred share (RBS.PR.B). The actual discount of the capital share RBS is only about 3.8%, as can be verified from the fund's info page posted by managers Scotiabank. That makes sense given that the fund invests only in the common shares of the country's biggest bank, Royal Bank of Canada, and only the presence of leverage in the form of the preferred shares complicates the situation. The lesson is that even good data sources such as the Globe can have errors. When investing, always check numbers, especially when they look strange!

Urbana Corp (URB or non-voting shares URB.A) 38.3% discount
This fund's holdings have until recently concentrated on investing in shares in stock exchanges such as the NYSE and the TSX. Various commentators have detected a potential value in this stock - e.g. the Globe and Mail's February 2012 article Finding blue chip bargains in closed-end funds, Frank Voisin who tracks Urbana's value and holdings in a spreadsheet on his blog, Barel Karsan blog's 2011 post Urbana: I Snooze, I Lose, Alpha Vulture's recent Urbana Update and ValueWalk's Urbana Corporation: A Net-Net Value Trap?. The opinions are mixed, with the discount set against poor returns of the last four years. There is also the issue of the recent move by URB to invest in Caldwell Financial, which happens to be URB's major shareholder. Both Caldwell and Urbana are headed by Thomas Caldwell who is the controlling shareholder. This snake eating itself move, though minor in proportion of the fund, raises questions about management's motives and interests. To cap matters, in the last few days, the stock has made a major move upwards, gaining 21% in the last five days. Could the love affair with stock exchanges and URB be returning to the point of 2007 where Urbana traded at a 60% premium to NAV?

Brookfield Soundvest Split Trust formerly called the Brascan SoundVest Rising Distribution Split Trust (BSD.UN) 34.2% discount
This fund displays a number of factors that could well justify a large discount - the steady shrinking NAV over the years; the suspension of redemptions and dividends on capital shares, the low credit rating (Pfd-4 by DBRS) on the preferred shares, which indicates shaky prospects for these shareholders who get paid before capital share owners. The investor looking at this situation may wonder whether the fund will shrink to nothing before the intended wrap-up date of 31 March 2015.

United Corporations Ltd (UNC) discount 34%
It would be a surprise on the other hand to see this fund disappear anytime soon. In existence since 1929, this large fund with $860 million in assets looks to be conservatively managed. It has continued to pay a dividend on common shares (it also has preferred shares in its capital structure) since forever and its total return looks comparable to the mix of Canadian and world indices matching its investment portfolio. The management fees are low enough to be ETF-like at 0.46% plus another 0.1% or so service fee to E-L Financial. The fund can understandably appeal to investors who subscribe to the fund's objective to achieve long term growth in common equities worldwide.

On the hand there are some caveats. The large discount is seemingly more less permanent. Going back to at least 1996, there has been a discount of anywhere from 20% to 45%. Mechanisms that might reduce the discount such as share redemptions, retractions or buybacks are flat out ruled out by fund policy. There is no automatic wrap-up date for the fund. Another fact, a limitation to some and an advantage to others who trust their ethics and judgment, is that the fund is controlled by E-L Financial, which is in turn controlled by the Jackman family.

With respect to the discount, though it might not go away, its historic range is quite wide and an investor could well see some lessening of it, leading to stronger returns if that happens, since the 34% is in the mid to upper historic range. It would be ironic to make trading profits on a fund with a hard-fast non-speculative philosophy.

Economic Investment Trust (EVT) 32.8% discount
This fund is very much like UNC. It is very old (1927 launch), low MER (only 0.32%), forever trading at a significant discount to NAV, big ($420 million in assets) and controlled by the same family with the same long term equity appreciation investment objective. EVT's discount has also seesawed, ranging from as little as 15% in 2006 to as much as 46% in January 2001. An eyeball look suggests that the discount has been greatest in times of economic and market turmoil. The biggest difference is that EVT has no leverage at all, no debt and no preferred shares either. Perhaps another discount reversion play while collecting dividends?

Canadian World Fund Ltd (CWF) 32.6% discount
This is another fund with many similarities to EVT and UNC - a chronic discount, a controlling shareholder, the Morgan family in this case, a long history (1994 foundation) and long term investments in a diversified portfolio. The big difference is a much higher MER at 2.3%, which reduces investor returns. The Morgan family also own the fund's managers Morgan Meighen so they get paid both ways. Investment returns have been poor with declining NAV, so perhaps the discount is in part the result of investors extending that trend.

Canadian General Investments Ltd (CGI) 27.7% discount
We've put this next in our rundown, though it isn't next in terms of largest discounts, because CGI is also controlled by the Morgan family. It sports a lower MER at 1.6% (includes 1% management fee plus 0.6% other expenses in 2011), though the overhead for CGI capital shares is 3.0% if the cost of leverage in the form of preferred shares is added. Investment returns based on its almost totally Canadian equity composition, have been much better than CWF's. The fund has a policy of making a constant $0.06 quarterly dividend payment then flowing through any remaining capital gains for the year in a one lump sum each December. The fund boasts of 25 year compound returns of 11.0% vs 8.2% for the TSX up to the end of 2011, though of course the leverage increases volatility as 2008 amply demonstrated. Given that the current discount is at the upper end of those of previous years, which has varied from 8% to 35% since 2008, maybe this is a chance to make a short-term trade or a long-term investment on the cheap.

CMP Gold Trust (CMP.UN) 31.9% discount
This is an another fund that has always experienced a very large discount to NAV since its 2008 launch. Compared to the year-end 2010 48.6% discount, today's figure is low! The fund has gone through huge swings in market price relative to the TSX. Management expenses have varied from a low of 2.53% in 2011 to 21.84% in 2010 as the incentive portion of the fee structure kicked in. Maybe investors are saying through the big discount that they aren't as sure of making money from this fund as the managers are.

Copernican British Banks (CBB.UN) 25.9% discount
We noted this fund last week because it was amongst the most discounted funds of 2008. It still is today in 2012. Though managers Portland Investment say that "...The discount is largely attributable to the redemption fee which expires in January 2014" and that "...investors will ultimately put fundamentals first and notice that this portfolio includes, what we believe, are substantially undervalued banks" the burden of bad bank history and the appreciable presence of European banks in the portfolio could well still be holding back investor belief. Or perhaps it is the hefty 3.08% expense ratio.

MBN Corporation (MBN) 23.7% discount
This fund's discount could well be called a confusion, uncertainty and complexity discount. From its start focussed on investing in oil and gas companies, it expanded after a merger this February to add mining and uranium. Now the Annual Information form says the "fund may make any investment which the Board and/or the manager determine to be appropriate".  Another statement says it intends to expand through acquisition of financial services companies and investment funds. Meanwhile the NAV return since 2007 inception is a minus 7.6% compounded.

Bottom Line
Several of these funds look attractive. UNC and CGI look best both short- and long-term. EVT and CWF look less attractive though still reasonably so. URB and CBB.UN are more speculative buys. BSD.UN, MBN and CMP.UN look dangerous. The February 2012 Globe article Seven closed end funds worth considering included CGI, CWF, UNC, EVF and CBB.UN in their attractive fund list.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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