Bargains can still be found: Buy closed-end funds at a discount

Timing is everything. Hit the website at the right time, and you get tickets to Bruce Springsteen and the E Street Band. Two seconds too late, and you're watching Bill and the Ankle Biters.

As far as we can tell — you never know what will happen next — the Standard & Poor's 500-stock index bottomed on March 9. It's up 34.1% since. You may feel you missed a chance to get the biggest bargains.

And you did. But you can still find plenty of bargains. The easiest to find are in closed-end mutual funds.

A closed-end fund is the earliest form of mutual fund and, frankly, they're relics of a bygone era. They have a structure that was first developed in the 1920s, and has long since been improved upon.

Like all mutual funds, closed-end funds are a professionally managed portfolio of stocks or bonds. And like exchange traded funds, you can buy and sell shares of closed-ends on the stock exchanges.

But unlike all other types of funds, closed-end funds issue a fixed number of shares. New closed-end funds raise money through an initial public offering and use that money to buy and sell stocks and bonds. In this sense, a closed-end fund is a bit like any company that's listed on the stock exchanges. One way to think of a closed-end fund is as a corporation whose business is buying and selling stocks.

What makes a closed-end fund peculiar is that its share price often doesn't reflect the value of its holdings.

Let's consider the Cohen & Steers Worldwide Realty fund, which trades under the ticker RWF. As of Wednesday, the assets in the fund's portfolio, minus expenses, were worth $4.48 a share. But the fund's shares sold that day for $3.38 — a 32.5% discount, in closed-end parlance. If the fund were liquidated that day, brand-new shareholders would get an instant profit of $1.10 a share.

Most closed-end funds sell at a discount, which has mystified academics for years. One theory is that closed-end funds don't liquidate very often. And if they were to sell all their holdings at once, they would have to do so at fire-sale prices.

But basically, closed-end funds sell at a discount because the fund's share price reflects what investors think of the fund's prospects, not its current value. Shareholders would be right to have a low opinion of Cohen & Steers Worldwide Realty fund. Its shares have plunged 76.9% in the previous 12 months, including reinvested dividends, according to Morningstar, the Chicago investment trackers.

Investors are often mistaken, though. As witness to this, a few funds sell for a premium — that is, for more than the value of their holdings. Pimco High Income, for example, sold at $8.59 a share Wednesday, even though the securities in its portfolio were valued at $4.74 a share, an 81.2% premium.

As you may have guessed, it's better to buy at a discount, not a premium. As proof, we looked at the entire universe of closed-end funds and ranked them by their premium or discount five years ago. We then created four groups — group one had the highest premium. Group four had the biggest discounts, and groups two and three were in the middle.

Group one sold for an average premium of 10.9%. The funds, which were a mix of stock and bond funds, lost an average 19.6% over five years. Group four, the cheapest funds, sold for an average discount of 8.3%. Average return: -4.1%.

Buying at a steep discount is no guarantee of profits. The Boulder Total Return fund sold for a 15.6% discount five years ago, and has since plunged 39%. Nevertheless, the universe of deeply discounted closed-end funds is a good place to start hunting for bargains. The Latin America Discovery fund, which sold for a 16.7% discount five years ago, has soared 123%.

Cecilia Gondor, editor of The Investor's Guide to Closed-End Funds, says that closed-end fund discounts are still huge, compared with their historical averages. The average discount is about 4%; it's 8% now. She favors closed-end municipal bond funds, which currently sport average tax-free yields of 6.4%.

Many closed-end muni funds use borrowed money to augment their yields, and that increases risks, too. Be sure to check that before you buy.

For the daring, closed-end real estate funds might be a good place to start. The Cohen & Steers management team is one of the best in its field. For technology buffs, Gabelli Global Multimedia Trust GGT is selling at a 25.4% discount.

You can find a great deal of information on closed-end funds, including premiums and discounts, at www.closed-endfunds.com, as well as www.morningstar.com. Choose your picks carefully. If you buy a closed-end fund at a discount, you may not have time on your side. But you will have price — and that's a big advantage.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. new book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com. Twitter: www.twitter.com/johnwaggoner.