Equities at a Discount, or Market Valuation of Managed Funds?
Charlie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Closed end funds tend to trade at discounts to their Net Asset Value (NAV) in recent years. I've not only wondered why that is, but if it portends a discount bargain for equities. Or could it be a generic proxy market valuation for managed funds. I and my family have long held and traded an ancient closed end fund - TriContinental (NYSE: TY) - I mean for decades, since the 50's in fact. Some years it actually traded at a PREMIUM! but for the last two decades it's mostly been at a persistently distressing 10-15% discount to NAV.
Looked at one way, you can buy a basket of equities managed by professionals with a (sort of) long track record at a 10-15% discount. Sounds very attractive right? But if you ever plan to sell, you then sell at that same 10-15% discount. Maybe, though, if you have REALLY LONG horizons, you can be patient enough to buy at a discount and sell in one of those shinning moments when it sells at a premium..... Ah yes, the fools' errand (ha had to get that in). Because, what really matters is price and not the premium or discount to NAV. Then there is the constant change in equities.... well you have PROFESSIONALS managing that.... and they buy and sell relentlessly to get you the best deal don't they? Well, ummm maybe not every time.
So lets just dive into the details for TY, an unusual candidate that has been around since 1929. TY's current 1 year returns are 30.4% on NAV and 31.55% on Market value. That's a fairly attractive bump, see what a discount to NAV does for you? But they have quite a long track record since 1929, and the NAV return since 1929 is a stunning 3.56%. Hmmm possibly less than stellar.
So what is this telling us? Maybe that we can buy an equity basket at a 10-15% discount to its underlying value and manage it to infinity at a good return, like say 3.56%. Or, perhaps this whole discount thing is the market telling us, when its free to do so, that managed buying and selling can be good for a while, but in the long run mistakes will prevail. The collective market will "hedge" active trading by discounting the value. Note that open ended Mutual Funds are constrained to trade at NAV every day. Maybe you should consider 10-15% the average damage that average mutual fund managers can do to your portfolio.
Could it be just this one fund with numerous fund manager changes over the decades? How about another one of entirely different make up, from the Gabelli Family, GDL Fund (NYSE: GDL). A modern fund with a track record from 2007, now trading coincidentally at 13.5% discount to NAV, and commonly in the range of 11-14% in recent months. Long term return since inception in 2007? 2.17%. Return for 1 year on NAV, 5.18%, and on Market value 10.13%.... not so much different in the long haul.
There have been many theories floated as to why closed end funds like TY and GDL trade at discounts to NAV in the "Modern World." My personal belief is that the market, when not constrained by "open" Mutual Fund rules tells us that on .average, the penalty for active management by "professionals" in the long haul is 10-15%. You can't count on Peter Lynch running your fund forever, and you can't count on the genius that got you 50% return last year to be running the closed end fund you like this year. I like what Buffet had to say on the subject of management - "buy a business that any idiot can run because eventually, any idiot will."
SkepikI has long positions in TriContinental and GDL Fund. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!