How to Buy a Dollar for 85 Cents

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how to invest in closed-end fundsNo matter how many times you slide a dollar bill into a change machine, you should always get four quarters back. It's just the way things work in the real world.

Thankfully, there are pricing discrepancies on Wall Street. There, you can buy a dollar's worth of stocks for $0.85 -- or perhaps even less than that. All you need to do is warm up to the sorely neglected realm of closed-end funds.

Open-ended Potential

What is a closed-end fund? Unlike traditional mutual funds, where shares are issued and redeemed on a daily basis, closed-end funds have a set number of shares outstanding. They also trade on stock exchanges throughout the day, like their more popular exchange-traded fund (ETF) cousins.

Closed-end funds have always gotten short shrift. They aren't actively marketed the way open-end funds and ETFs are. However, thrifty investors can't ignore that most of the general stock-based closed-end funds trade at a discount to their net asset value -- or NAV.

There are hundreds of closed-end funds, taking up two full pages of weekly quotes on Barron's. Only about a third of closed-end funds are equity-based vehicles, with the balance dedicated to fixed-income offerings.

There is a big operating advantage to closed-end funds over conventional mutual funds. Since the outstanding shares remain constant, a closed-end-fund manager doesn't have to worry about cashing out redemptions when times are bad or putting new money to work when the going is good. Fund managers can stick to their investing philosophies, remaining fully invested during the inevitable market volatility.

Since there is no incentive to spend on marketing, closed-end-fund expenses can be fairly reasonable. The problem -- and also the opportunity -- is that this makes closed-end funds poorly promoted investment vehicles.

Toiling away in the shadows means that many of these funds trade for less than the value of their portfolios, unlike open-ended funds that are bought and sold at the exact NAV.

Fun with Funds

Let's use Adams Express (ADX) as an example. Adams Express has been around since 1929, and it's been consistently paying dividends since 1935.

The closed-end fund closed at $9.35 on Friday. Its NAV -- the value of its assets minus its liabilities -- closed out the week at $11.01 per share. The stock is trading in the open market at a 15% discount to its theoretical liquidation value -- giving buyers a dollar's worth of stocks for $0.85.

Investors aren't buying snake oil, either. Adams' largest holdings include household names such as Apple (AAPL), McDonald's (MCD), and PepsiCo (PEP).

How does buying Apple at a 15% discount sound? Well, Apple accounted for just 2.8% of the fund at the end of June. However, getting more bang out of your buck by buying into this basket of established stocks has to be a tantalizing proposition.

Tri-Continental (TY) is another fund trading at a 15% discount. Apple, Microsoft (MSFT), and Chevron (CVX) were its three largest holdings at the end of August. Tri-Continental also launched in 1929, and its 0.6% expense ratio compares favorably with the average open-ended mutual fund.

Fund investors may be familiar with value investor Charles Royce. He watches over the popular Royce family of open-ended mutual funds. Did you know there are three Royce closed-end funds, owning many of the same stocks that the traditional funds do but at a 13% to 15% discount to NAV?

There's no free lunch
There is a catch, and it's a pretty big one. The only reason you can buy into Adams Express or Tri-Continental for $0.85 on the dollar is that an earlier investor is willing to sell them to you on the same terms. In other words, buying in at a 15% discount doesn't mean you'll be able to cash out at full price.

Only a liquidation event would make that possible, at which point I should once again remind you that these funds have been around since 1929.

However, the operating advantages of closed-end funds and the leveraged nature of the discount should be enough to intrigue you into digging a little deeper. Just because most investors ignore closed-end funds, that doesn't mean that you should miss out on the opportunity to get more bang for your buck.

Longtime Motley Fool contributor Rick Munarriz owns no shares in any of the stocks in this article. The Motley Fool owns shares of Apple, Microsoft, and PepsiCo. Motley Fool newsletter services have recommended buying shares of Chevron, PepsiCo, Microsoft, McDonald's, and Apple, creating a bull call spread position in Apple and Microsoft, and creating a diagonal call position in PepsiCo.



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14 Comments

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steve thompson

ALL of my money has been pulled from the manipulated , propped up, QE'3'd, tainted , stock market. I sleep better at night. Dow 3000 by summer 2012.

October 18 2011 at 11:51 AM Report abuse rate up rate down Reply
kevinclennon

sounds like a obama plan turn your dollar into 85 cents. just print more money.

October 18 2011 at 11:09 AM Report abuse rate up rate down Reply
Ghetto Cat

I thought I was gonna be rich!
Do you get the .85 back?
Probably not!
So now you gave .85 to a box that had nothing.
They go and strip the economy with your .85.
When they are done they've stolen 2.85!
They give you .15 and everybody is a sucker, LOL!

October 18 2011 at 5:43 AM Report abuse rate up rate down Reply
rsargerod

Her goes another Wall Street idea tha produces nothing.

October 18 2011 at 1:32 AM Report abuse rate up rate down Reply
theshadow795

Just stick all your money into Wall Street. They aren't done taking it all yet. Margin Call gentlemen.

October 17 2011 at 8:32 PM Report abuse rate up rate down Reply
f4180

Thats easy . Make 85 cents for a dollar ? just invest in your 401K while we still have that tomato brain in the whitehouse .

October 17 2011 at 5:41 PM Report abuse rate up rate down Reply
2 replies to f4180's comment
redwingirish

You're too late...He left for crawford years ago!

October 17 2011 at 7:23 PM Report abuse +2 rate up rate down Reply
Setanta

they're simply acclimating future retirees for the return on ALL THE MONEY garnished from their paychecks and going over to FICA---wasn't THAT WHAT THEY reckoned ? if you're LUCKY ??? 85cents on the dollar ? I don't even think you get that amount RIGHT NOW--some of us are working legit and paying ALL withholding sonve 14 or 15....whaT a royal rip off !!!!!!!!!!!!!

October 17 2011 at 10:48 PM Report abuse rate up rate down Reply
Setanta

460 DAYS TO DEFEAT OBAMA !
GET MOVING and KEEP MOVING !

October 17 2011 at 5:02 PM Report abuse rate up rate down Reply
2 replies to Setanta's comment
theshadow795

It's not going to happen.

October 17 2011 at 8:33 PM Report abuse +1 rate up rate down Reply
pozboys

What genius from the republican side, would you put in place?? Any thinking person has got to be appalled at what they are offering for an "alternative"! Give the country a break!!

October 18 2011 at 11:21 AM Report abuse -1 rate up rate down Reply
hemipwr54

A Global Economy but America prints the money .
China purchased the Dollar for $.25 , in order to fund America you have to buy things that were Made in China .

October 17 2011 at 3:31 PM Report abuse rate up rate down Reply
2 replies to hemipwr54's comment
dxman7

Yes, dude. We all should start learning Mandarin.
The American Style/fashion is now handled by China. As a small example, you may
look at the market; you will find there toothbrashes designed and made for monkeys
and sold to Americans. Apparently, the glory of America has gone !

October 17 2011 at 5:34 PM Report abuse rate up rate down Reply
pozboys

That will work as long as Americans can afford to buy! Its getting harder to do that, with no work!!

October 18 2011 at 11:23 AM Report abuse rate up rate down Reply