The ease of adapting Drach’s methods to closed-end funds is based on the similarity of scanning for relative discounting. The essence of the timing technique is to attempt to expand common stock investment when the overall market is relatively low, confining investment interest to stocks that qualify for the Master List, which appear relatively discounted to the others.

Scanning for the most appropriate closed-end fund based on discounts has the same objective: isolating the cheapest. In Drach’s objectives, he is searching for specific stocks that are overly discounted. In Herzfeld’s closed-end fund analysis, he is searching for the most discounted fund. The focus of both techniques is to isolate excessive discounts relative to historical/statistical norms.

A significant differential between Drach’s concentration on specific stock and Herzfeld’s concentration on specific funds is that the funds, by their structure, involve diversity in the number of different positions.

FundsAs can be seen in Appendixes C, D, and E, listing Drach’s published results, he has been successful in approximately 49 of every 50 stock positions. Although the probabilities are quite low, it is possible for a portfolio lacking diversity to be overly exposed in the few losing positions. Also, as the results demonstrate, there is a wide variance in the degree of profitability in individual stock positions. A portfolio lacking full diversity could by chance be weighted in the lower spectrum of profitability or by the same chance far outperform Drach’s published modeling by being weighted in the more profitable trades.

In almost all closed-end equity funds, some positions fail to qualify for Drach’s Master List and consequently carry the probability of underperforming the Master List issues. In other words, the diversity of holdings in a closed-end fund can make the fund underperform Drach’s specific stock selections, but can smooth returns. Stated differently, the pricing volatility inherent in Drach’s head-on, rigid approach to specific common stocks is reduced in closed-end fund application.

The decision to utilize specified stocks or closed-end funds in our techniques depends on the individual investor’s goals, needs, and resources, as on well as the ability to withstand psychological pressures.

The investment techniques described in my blog can be divided into five basic trading strategies (you can find the others in my blog) :

  1. Time Overlay
  2. Bonds
  3. Continuous Full Investment without hedging
  4. Continuous Full Investment with hedging
  5. Long-Term

Time Overlay

The application of the timing method to closed-end funds is straightforward. The degree of exposure to common stocks (investment level) varies with buy/sell indications. Using the Composite investment level as a guide, the percentage of monies allocated toclosed-end funds versus the percentage retained in cash equivalents parallels the composite figure.

The Composite investment level is based on factors affecting the pricing of common stocks. Consequently, the closed-end funds surveyed for possible purchase are those heavily weighted in equity investment (stocks or, in some instances, convertible bond funds). Funds that can quickly and dramatically alter their asset allocations (percentage changes in stocks, bonds, and cash) are less suitable than those that maintain heavy equity exposure because the fund’s allocation changes run the risk of mismatching our investment level.

The selection of specific funds is the result of surveying the discountdifferentials, with those funds demonstrating the greatest discounts relative to their historical norms generally preferable.

For example, if you had purchased Morgan Greenfell SMALLCap Fund, Inc. in February 1990, when Drach issued a buy recommendation, you would have been buying the fund at a 14-percent discount to net asset value, at $81/2. Beginning in May 1990, when Drach announced his sell recommendation, and through July 1990, you could have sold the fund asit narrowed to a 3-percent discount from net asset value at 11 to 111/2, a gain of approximately 35 percent.

Throughout the August and September 1990 buy signals, you could have purchased H&Q Healthcare Investors, Inc. at a wide 21-percent discount, trading at 87A3. When investment level was reduced in February, March,and April 1991, the fund had narrowed to 3- to 5-percent discounts, and the price had increased to 13.

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Applying Specific Market Timing and Selection Techniques to Closed-End Funds