Make money from closed-end funds

The key to profiting from closed-end funds in Canada is to always remember that they will normally trade at a discount. It’s the depth of the discount that offers the greatest opportunities.

Be on the watch for potential profits when a discount becomes unrealistically large. There are several possible strategies:
Bargain hunting:
Investors see shares in the fund are trading at a low price relative to the fund’s assets.

For example: Suppose the net asset value of shares in the High Flyers closed-end fund is $10, but they’re trading for only $6 on the TSE — a 40 per cent discount.

Bargain hunters may bid up the price to $7, reducing the discount to 30 per cent. If you bought in at $6, you’d make a quick profit of almost 17 per cent in this situation.
Range watching:
Many closed-end funds trade within a predictable range — say a 25 to 35 per cent discount of t net asset value (NAV). Astute investors keep track of the price movements and buy when shares are trading in the low end of the range. 

When the price moves back to the high end, they sell and wait for the cycle to repeat.
Fund wind-up:
When a closed-end fund is wound up, all outstanding shares are redeemed at the final net asset value. Anyone who bought in at a discount stands to make a profit in this situation.
Kinds of wind-ups:
When the fund was launched, a date was set for its wind-up. The process is an orderly one and the trading price of shares will gradually rise (or fall) towards the NAV as the wind-up date approaches.
Shareowners force the wind-up of the fund by special resolution.

This can happen when shares consistently trade at a deep discount to NAV. By forcing liquidation, the shareowners are able to recover the full asset value of their holdings.

Forced liquidations are unpredictable and, as a result, can produce windfall profits for investors who buy in at low prices.
Conversion: A fourth way to realize quick profits from a closed-end fund is as a result of conversion to open-end status.

This has happened more frequently in recent years as shareowners, unhappy with low stock exchange prices, approve special resolutions converting what was originally a closed-end fund to open-end status.

This enables shareholders to redeem their units at net asset value, rather than being forced to sell them on a stock exchange at a discount.
Recent example
One recent example of a conversion from a closed to an open-end fund involved the Templeton Emerging Markets Appreciation Fund, which was merged into the open-end Templeton Emerging Markets Fund in September 2001.

The closed-end version had been trading at a significant discount to NAV (13.7 per cent as of June 2001), so the merger enabled unitholders to realize full value for their positions.

As you can see, there are numerous ways to invest in closed-end funds. However, this is a specialized area so you may wish to obtain professional advice before venturing into it.

Adapted from Gordon Pape’s 2002 Buyer’s Guide to Mutual Funds, by Gordon Pape and Eric Kirzner, published by Prentice Hall Canada.