(The views expressed here are those of the author, the founder

of FridsonVision High Yield Strategy.)

By Marty Fridson

April 1 - Closed-end funds trading for less than the

value of their underlying holdings are frequently identified as

market inefficiencies, offering investors the opportunity to

snap up bargains created by short-term supply/demand

aberrations. However, a cursory dip into the data dispels any

notion that discounts to net asset value (NAV) represent easy

pickings for those seeking superior returns.

One might expect that a closed-end fund (CEF) - an

investment vehicle that raises capital by issuing a specific

number of shares - should trade at roughly the same value as the

assets it holds. That is why financial pundits offering advice

on CEFs often point to a discount to NAV as a clear "buy"

signal.

Let us suppose that discounts to NAV truly represent

temporary anomalies that investors can count on the market to

correct before long. We should then expect to find the most

deeply discounted CEFs - by this logic, the most underpriced -

among the group's best performers for the succeeding 12 months.

Following the same reasoning, investors would certainly not

want to buy a CEF trading at a premium to NAV, as that would

mean paying more than the aggregate price required to create the

fund's portfolio on one's own.

However, the performance in 2024 of some of the largest

actively traded U.S. CEFS throws cold water on all those

assumptions.

DISCOUNT VS. PREMIUM

I compiled a list of the 30 biggest CEFs by market

capitalization, according to Stock Analysis, and I found that

the fund that began the year with the largest premium to NAV

posted a 19.9% total return. That exceeded the 16.6% return

generated by the S-Network Composite Closed-End Fund Index for

the same year.

How about the CEF that began 2024 with the steepest

discount, which should have been the best buy within the group?

It merely matched the 19.9% total return of the fund that

started with the biggest premium.

If buyers found that disappointing, they could at least

console themselves that they did not buy one of the nine

discount-to-NAV funds that underperformed the index, with total

returns as low as 2.4%. By contrast, the worst total return for

a premium-to-NAV fund in the sample was 17.2%.

A simplistic strategy of buying the 15 funds initially

trading at the biggest discounts to NAV would therefore clearly

have backfired. The CEFs with prices ranging from 17.6% to -9.2%

of NAV delivered an average return of 23.9%. Those with prices

ranging from -12.6% to -20.2% of NAV returned just 19.7%.

While the large standard deviations within my modestly sized

samples make it impossible to assign any statistical

significance to the differences between the average returns, it

is nevertheless clear that these CEFs' performance depended on

much more than their beginning-of-period valuations vis-à-vis

their NAVs.

Discount devotees might downplay the outcomes reported here,

saying that perhaps 2024's returns were anomalous. Certainly,

relative return relationships can vary from year to year. At

the very least, however, last year's results demonstrate that

picking CEFs solely on the basis of NAV discounts is not a

perennially successful strategy.

NO MAGICAL SHORTCUT

A CEF's price relative to its NAV is certainly one data

point to consider when assessing a fund's investment merits. But

it is not a magical shortcut that justifies skipping all of the

other analytical steps necessary when sizing up any type of

security.

While temporary market inefficiencies may explain a portion

of a fund's discount to NAV, so may terrible management over an

extended period. And if the managers who delivered awful

performance are still in place, then it is highly likely that

the CEF's underperformance will continue.

To be sure, it is always possible that an activist manager

will ride to the rescue, gain control of the fund, liquidate it,

and give investors who bought at deep discounts far more than

what they paid per share. However, that did not happen in 2024

to any of the discounted CEFs in my sample, suggesting that it

is unwise for investors to count on being bailed out in that

fashion.

Ultimately, one can reasonably argue that financial markets

are not perfectly efficient, but it is not valid to assert that

exploitable inefficiencies are as abundant - or as highly

visible - as CEFs trading at a discount to NAV. So investors

should get back to analyzing fundamentals and leave the rules of

thumb to the financial pundits.

(The views expressed here are those of Marty Fridson, the

founder of FridsonVision High Yield Strategy. He is a past

governor of the CFA Institute, consultant to the Federal Reserve

Board of Governors, and Special Assistant to the Director for

Deferred Compensation, Office of Management and the Budget, The

City of New York).

(Writing by Marty Fridson; Editing by Anna Szymanski.)