The Secret in Saturday's Globe & Mail
Of course, it's not exactly a secret, because it's in plain sight, but I'd guess that few investors know of it or understand what it is. In the back of the Report on Business, you'll find a block of text with the heading "Fund Asset Values". That's our boy.

What is it? Well, it refers to a particular type of investment vehicle that a lot of investors have never heard of. Just by way of reminder, it's important to remember that, after choosing to invest in a particular asset class (i.e. Canadian Equity, Income Trusts, Bonds, etc), an investor must still decide which type of investment vehicle to use. And though the choice seems daunting, most investments can be slotted into one of three categories: traditional mutual funds, individual securities, and … the contents of the above-mentioned block of text in Saturday's Globe & Mail - Closed-End Funds (CEFs).

CEFs are significantly different from mutual funds. When a mutual fund receives a buy order, the fund company itself receives those additional funds. Sell orders similarly reduce the amount of assets under administration. Investors in effect always buy and sell with the fund itself. Therefore, the assets held in any particular mutual fund can dramatically expand or shrink depending on the popularity of the fund.

CEFs are different. The CEF fund company issues shares to the public only once. Then, if I purchase shares after that, I buy them, not from the fund company, but from another investor - on the stock exchange. The fund company no longer transacts directly with investors, so there's less need to hire staff to process investors' transactions. Presto! Fees are lower. CEFs aren't compelled to sell holdings at inconvenient times to cover withdrawals, nor buy regardless of the price simply because they are experiencing large inflows. They can stick to their long-term plan regardless of investor behaviour.

CEFs are very diverse. I have long used CEFs to invest in Russia, East Europe, and other countries where you cannot invest via mutual funds. There are CEFs devoted to bonds, income trusts, equities, and almost any other specific financial product you can imagine.

But the biggest benefit of CEFs is the ability to buy them cheap. Traditional mutual funds always trade at their net asset value - which is completely fair, of course. But I'd prefer to get a baragin! Because CEFs trade on an exchange, they are free to trade above or below their fair price - the net asset value per share (NAV). This premium or discount to NAV is the information provided weekly in Saturday's Globe & Mail. (I must caution you that the numbers in Saturday's Globe & Mail are sometimes incorrect, so independent verification is essential). You can buy $1.00 of assets for $0.90, or $.80, or even less. That's a great bargain: you have more money working for you than you put in. Over time, you should outperform other funds not trading at a discount. Eventually, most discounts disappear. Astute investors can profit not just on the underlying investment, but also by getting an extra kicker from the discount. It's like buying a house worth $200,000 for a bargain price of $160,000, and then, a few years later, selling it for $320,000 when it's really worth only $300,000. It improves your odds dramatically.

You can invest like that using CEFs. I've done it. If a CEF is available at a large discount - I'll buy it, if not, no thanks. There are some CEFs I have been interested in for over a year now, but I'm still waiting for a discount to appear before buying for my clients. Currently, income trust CEFs are very numerous. You can find a bunch of them trading at discounts of 6% - 11%, while others trade at premiums of 4% - 8%, for a net difference of 12 - 19%. Buy at a discount, sell at a premium, then repeat. Pass GO. Collect $200. Win the investment game. Retire on Boardwalk, instead of Baltic Avenue.

All right, so what are the disadvantages? There are three. Commissions. You must pay a commission to buy and sell, unlike mutual funds. Rebuttal: The lower management expense ratios of CEFs, and the ability to take advantage of discounts can offset this. Transaction Size. Mutual funds allow tiny transaction sizes, sometimes as low as $25, whereas CEFs require you to purchase shares on an exchange in the minimum quantity proscribed by the exchange. Rebuttal: None. Mutual funds are much more flexible and convenient for small withdrawals/purchases. Lack of liquidity. CEFs have varying degrees of liquidity, meaning that some don't trade in huge quantities, and it may be difficult to buy/sell large amounts (say $100,000 or more) at one time. Rebuttal: Take this into account when investing in CEFs, if it is likely to be an issue. I have found that less liquid issues sometimes offer the best value - i.e. the largest discounts.

It is important to understand that CEFs are not necessarily the best investment vehicle for all occasions. In some cases, mutual funds will be superior, and in others, individual securities might be the best bet. But CEFs can be an important addition to your portfolio. I do a lot of business in them.

In addition to specializing in particularly promising foreign markets, I also have a particular focus on CEFs, simply because I see them as offering such spectacular value. Not many advisors pay them much attention. If you'd be interested in learning more about how you might incorporate them into your financial plan, give me a call. I can promise you that I will give you an unbiased review, with a pre-disposition to preserving capital and seeking out under-valued assets that should appreciate over time. I have over 16 years experience in financial services, both in Canada, and in Singapore and London. Call me today for a free, no-obligation consultation. It will be well worth your time.

Sincerely,

Scott Swallow, HBA, MBA, CIM