How to Buy Wells Fargo at a Discount

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Want to buy the market at a discount?  Currently, you can buy fund that is close to replicating the market for 12% below the value of the stocks within the fund.  This fund is called Liberty All-Star Equity Fund (NYSE: USA). The patriotic ticker is another bonus.  The fund holdings look a lot like the SPDR S&P 500 ETF (NYSEMKT: SPY).  The big difference is that SPY is based on the market index where USA is actively managed by 5 different investment firms.  Most holdings are similar in proportion.  One of the exceptions is Wells Fargo (NYSE: WFC).  USA holds more Wells that SPY. This may not be a bad thing given that Warren Buffett is buying more, according to a recent CNBC interview.  Wells has been considered as a franchise company in Buffett’s collection of great businesses. 

Unfortunately, there are some negative aspects about USA relative to a market ETF like SPY.  First, USA collects a larger fee for managing the fund.  USA has a fee of 1.05% per year and SPY has a fee of only 0.1%.  Another big difference is that SPY is redeemable at net asset value where USA is not redeemable so the market price can move away from the actual value of the stock holdings in the fund.  

So why buy this fund as opposed to some other discounted closed end fund?  First of all, USA has a dividend yield of 6% of NAV which translates into about 6.8% of the stock price.  Most importantly, USA is partially owned by an activist investor: another closed-end fund with a history of convincing management to bring out more value.  This fund is called the Special Opportunities Fund (NYSE: SPE)This fund actually trades at a discount too.  SPE was able to make big changes in one of USA’s sister funds, Liberty All-Star Growth Fund (NYSE: ASG).  SPE bought shares in ASG at a double-digit discount to NAV and asked the management to offer a tender for the shares.  The management agreed and offered to buy back shares at 5% below NAV.  This tender offer raised the stock price to around 8% below NAV.  SPE stated in their semi-annual report that “We intend to resume discussions with management about USA’s discount in the near future.” 

If the management had a tender offer for ASG shares, why wouldn’t they be willing to do the same for USA?  If you buy today at a 12% discount, tender half of them at a 5% discount and sell the rest at an 8% discount, that is a 5.5% gain.  Plus, you will receive a return on the holdings and the 6.8% yield in the meantime.  An investor could always hedge out the market exposure if they just wanted the potential alpha. 

In 2011 and 2012, the discount has varied considerably.  It was as high as 15% and as low as 8%.  The present discount of 12% may not be the best you could receive; however, the investor still has a high probability to make a return greater than the market.  This closed end fund with a near term catalyst is certainly worth a look.

mthiessen has a long position in Liberty All-Star Equity Fund  mentioned above. The Motley Fool owns shares of Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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