The Closed World Of Clos E De N D Funds

Closed-end stock funds, although popular during the 1980s, have slowly atrophied. Today, there are only 30 diversified domestic

9 Investors can search easily for funds that meet these expense hurdles by using the fund-screening tools at www.morningstar.com and http://money. cnn.com.

10 See Matthew Morey, "Rating the Raters: An Investigation of Mutual Fund Rating Services" Journal of Investment Consulting, vol. 5, no. 2, November/ December, 2002. While its star ratings are a weak predictor of future results, Morningstar is the single best source of information on funds for individual investors.

equity funds, many of them tiny, trading only a few hundred shares a day, with high expenses and weird strategies (like Morgan Fun-Shares, which specializes in the stocks of "habit-forming" industries like booze, casinos, and cigarettes). Research by closed-end fund expert Donald Cassidy of Lipper Inc. reinforces Graham's earlier observations: Diversified closed-end stock funds trading at a discount not only tend to outperform those trading at a premium but are likely to have a better return than the average open-end mutual fund. Sadly, however, diversified closed-end stock funds are not always available at a discount in what has become a dusty, dwindling market.11

But there are hundreds of closed-end bond funds, with especially strong choices available in the municipal-bond area. When these funds trade at a discount, their yield is amplified and they can be attractive, so long as their annual expenses are below the thresholds listed above.12

The new breed of exchange-traded index funds can be worth exploring as well. These low-cost "ETFs" sometimes offer the only means by which an investor can gain entrée to a narrow market like, say, companies based in Belgium or stocks in the semiconductor industry. Other index ETFs offer much broader market exposure. However, they are generally not suitable for investors who wish to add money regularly, since most brokers will charge a separate commission on every new investment you make.13

11 Unlike a mutual fund, a closed-end fund does not issue new shares directly to anyone who wants to buy them. Instead, an investor must buy shares not from the fund itself, but from another shareholder who is willing to part with them. Thus, the price of the shares fluctuates above and below their net asset value, depending on supply and demand.

12 For more information, see www.morningstar.com and www.etfconnect. com.

13 Unlike index mutual funds, index ETFs are subject to standard stock commissions when you buy and sell them-and these commissions are often assessed on any additional purchases or reinvested dividends. Details are available at www.ishares.com,www.streettracks.com,www.amex.com, and www.indexfunds.com.

KNOW WHEN TO FOLD 'EM

Once you own a fund, how can you tell when it's time to sell? The standard advice is to ditch a fund if it underperforms the market (or similar portfolios) for one—or is it two?-or is it three?-years in a row. But this advice makes no sense. From its birth in 1970 through 1999, the Sequoia Fund underperformed the S & P 500 index in 12 out of its 29 years-or more than 41% of the time. Yet Sequoia gained more than 12,500% over that period, versus 4,900% for the index.14

The performance of most funds falters simply because the type of stocks they prefer temporarily goes out of favor. If you hired a manager to invest in a particular way, why fire him for doing what he promised? By selling when a style of investing is out of fashion, you not only lock in a loss but lock yourself out of the all-but-inevitable recovery. One study showed that mutual-fund investors underperformed their own funds by 4.7 percentage points annually from 1998 through 2001-simply by buying high and selling low.15

So when should you sell? Here a few definite red flags:

• a sharp and unexpected change in strategy, such as a "value" fund loading up on technology stocks in 1999 or a "growth" fund buying tons of insurance stocks in 2002;

• an increase in expenses, suggesting that the managers are lining their own pockets;

• large and frequent tax bills generated by excessive trading;

• suddenly erratic returns, as when a formerly conservative fund generates a big loss (or even produces a giant gain).

14 See Sequoia's June 30, 1999, report to shareholders at www.sequoia fund.com/Reports/Quarterly/SemiAnn99.htm. Sequoia has been closed to new investors since 1982, which has reinforced its superb performance.

15 Jason Zweig, "What Fund Investors Really Need to Know," Money, June, 2002, pp. 110-115.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

Get My Free Ebook


Post a comment