Description
This article is from the A Guide to
Closed-End Funds (CEFs).
Trading Closed-End Funds: Selecting Candidate CEFs
- Buy at large relative discounts.
The crux of the trade is in buying
when the CEF is deeply discounted in comparison to its normal
discount. Such situations are usually brief, typically occur during
the week, and occur only occasionally, when investor sentiment sours
abruptly.
- Buy at a deep discount.
Try to always buy at a discount of 10% or more,
if at all to give yourself some protection against continued downward
movement in the market. In such cases, there is a good chance that the
discount will narrow to its normal range, thereby giving you the
opportunity to bail out of a potential bad trade. Of course, there is
no guarantee that the discount will not continue to widen, but usually
this is very rare, especially given that, from the first guideline, it
is already well below its normal discount.
- Buy funds with good "bounce-back" potential.
The truth is that all funds that invest in a particular market are not
equal. Investors, for whatever irrational reasons of their own, show a
strong preference for older established funds. Consequently, the Asia
Pacific fund trades at a far higher premium than newer funds like the
Templeton Dragon fund, the Asia Tigers fund, the Fidelity Advisor
Emerging Asia fund and the Emerging Tigers fund; the Templeton
Emerging Markets fund trades at a far higher premium than newer funds
like the TCW/DW Emerging Markets Opportunities Trust and the Emerging
Markets Infrastructure fund. Oddly enough, the older funds offer more
opportunities for trading, since at bad times they have further to
fall. But they tend to bounce back very sharply when the markets move
up. Other funds include the Singapore fund, the Scudder New Asia fund,
the Korea fund, the India Growth fund, the Taiwan fund, and so
forth.
- Buy funds whose underlying markets have a good "bounce-back"
potential.
After all, the trader is looking for a sharp 15% rise, so the
underlying markets must be strong investor favorites. The hope is that
bad news has pushed the market down sharply, (and the CEF even more
sharply), so that the 15% move up in the next few weeks would
basically be a recapture of a portion of earlier losses. Many of the
Asian markets, emerging markets, and sectors like gold, health-care,
and technology exhibit reasonable volatility.
- Buy when investor sentiment in the US is low.
Though most of the CEFs are funds that invest in foreign markets,
domestic investor sentiment still plays a critical role in determining
the discount of the CEF since the funds are traded on the domestic
exchanges. Often good buying opportunities arise when the US market
sells off pushing the CEF price down, but the market in which the fund
invests in remains stable keeping the NAV steady.
So the above are basic guidelines for identifying candidate
CEFs. If you use our service, the search for good candidates can be
greatly simplified.
- Check the investor sentiment indicators to see what the
short-term and long-term outlook is for the market. The more critical
one is the short-term indicator. The more sharply it has changed and
the more negative the reading, the better the potential for a quick,
sharp bounce up.
- Check the short-term (13 weeks, 15 weeks or 26 weeks) relative
discount tables to identify funds that are selling at wide relative
discounts (at least -8%).
- Filter out funds that are not selling at a reasonable discount,
usually at least -5%, preferably -10%.
- Of these funds, select CEFs that have sharp bounce-back potential
and whose markets have dropped off considerably from recent highs. A
study of the daily hilo (long) chart and the weekly closing chart
usually gives a good picture.
The funds that are now under consideration are candidates for
trading.
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