With all of the Washington turmoil of late (ok, maybe years would be more accurate) and the massive debts being incurred, many people have been surprised by the stock (and bond) market’s resiliency. Now, arguably that is all credit to The Fed, but still, it has been a pleasant occurrence regardless. Will it continue? Of course, no one has any idea, but it seems all but certain that the bond market will get hit. It already has these past few months, but even The Fed has talked up its “tapering” program. It may very well turn out that all of that talk was all that was needed to get the bond market to plunge and The Fed will just go merrily about its business of money printing (or, some may say, offering liquidity) unabated. But, these last few months have given more than a few bond owners a wake up call. Whenever The Fed decides the party really is over, Katie bar the door. The losses will pile up and more likely than not, it will happen in quickly and in bunches. Stocks too, may not enjoy happy times once The Fed decides that it is time.
Which brings me to closed-end funds. For those of you with cash on the sidelines this is an area that could offer up some great bargains during any downturns. There are certainly some areas that even now could end up as good investments, but this post is going to concentrate on what to look out for during downward waves. The reason for this is that in the closed-end fund world, it is possible to actually buy bonds and stocks below their value. That’s right, it is possible to buy assets below where those assets are currently trading.
Closed-end funds is a bit of an ignored section of the investment world and is thus far less known than those of its cousins, mutual funds and ETFs. But closed-end funds have some advantages over those two and disadvantages too. But, especially during bad times in a sector, it is definitely possible to buy $100 worth of stocks for, say $85. The reason for this is that while they are mutual funds, they trade like stocks. So, let’s say that blue chip stocks have recently taken a beating (obviously not the most likely sector, but good for illustration purposes) and investors are heading for the exits. A blue chip mutual fund trading on the NYSE (a closed-end fund in other words) may very well get caught in the feverish demand of people wanting to get out. As with any stock, the closed-end fund will trade based on supply and demand. If more people want to get out at a price than there are people willing to pay that price to get in, then the fund (stock) will continue to move lower until a buyer is found.
When this occurs, the fund could begin to trade below the actual value of the stocks (or bonds) in the fund. In the case of blue chip stocks and bonds, that could mean that not only are you buying the assets cheap, but your yield is also much higher than it would be possible to get elsewhere. For those of you hunting for greater yields, this can be a great spot to go looking for buys.
Now, there are some fairly significant caveats with this strategy. First and foremost among them is the simple fact that there is no guarantee that the fund will go back up in value. In fact, as you know, certain sectors can fall out of favor for long periods of time. This could mean that while you may have bought the fund for less than its underlying assets, that does not mean that you will be able to sell it at any higher price than you paid for it. If that sector continues to plunge, then it is highly likely that your fund will too. Also, there are some closed-end funds that are a bit tricky. Leverage is used in many funds with yields and while that is really not a problem in normal markets it can be in riskier sectors. For example, if you have a leveraged junk bond fund, then the leverage could mean higher losses to come as the underlying bonds may go bankrupt in very bad economies especially. So, be careful, but if you have some powder dry and are waiting for some bargains to avail themselves, don’t forget to look at the closed-end bond area.