Pricing
When buying or selling either an open-end or closed-end fund, an investor usually knows the current value of the fund’s assets per share (NAV).
For example, to buy an open-end fund with a NAV of $15, an investor pays $15 per share. The fund simply issues new shares to the investor at the current NAV. The assets the fund manages have increased, but the value per share remains the same because the new shares have exactly the same value as the other shares. If the investor sells, he or she is paid the NAV. The amount of assets the fund manages has been reduced, but the NAV of outstanding shares has not changed because the shares redeemed were equal in value to all others.
With closed-end funds, the shares are traded in the open market and are consequently subject to demand/supply imbalances. They may trade at a price greater than their NAV (termed a premium) or at a price below the NAV (termed a discount). Read the rest of this entry »
In determining which specific closed-end fund provides the best buying opportunity, it might appear that the process is exceptionally simple: Just see which one is selling at the widest discount and buy it.
Unfortunately, the process is a bit more complicated. As previously discussed, there are valid reasons for discounts. There is also a wide variety of fund types: equity (stocks in general or in industrial sectors), bonds (different types, such as municipal, corporate, foreign, or U.S. government; all with varying maturities), convertible bonds (combining both bond and stock characteristics), specialty (confining interest to a specific country, a very narrow industry sector, venture capital, or specific private placements), dual-purpose (where the fund seeks both capital gains and income), or anything else that can generate public interest and enough sales to capitalize the fund. Read the rest of this entry »
Since almost all closed-end funds tend to sell at a discount, it can appear obvious that there is no reason to purchase closed-end funds when they are selling at a premium. Sometimes a special feature, for example, a closed-end fund having a private placement in its portfolio which is about to go public as a hot issue, may justify purchase at a premium. Otherwise, it is difficult to make a case for paying a price higher than NAV.
Central to the advantages of closed-end funds is the discount; both as to dividends and as to pricing variances. Read the rest of this entry »
A primary reason for discounts is a lack of sponsorship. If a securities salesperson (dependent on commissions) has a choice of selling someone an existing closed-end fund (say at a regular stock commission of around 1 percent) or a load mutual fund with a sales charge (that can be as much as 8 percent), the incentive is to direct “investors” to the open-end fund.
The incentives associated with higher sales charges can be easily observed when new closed-end funds are issued. In new issues, compensation is by underwriting fees. A typical fee is 7 to 8 percent. If a fund was coming public at $10 per share, an 8-percent underwriting fee would be 80 cents per share. Read the rest of this entry »
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. Read the rest of this entry »
In both the primary and many of the ancillary criteria that determine buy/sell signals, interest rate projections play an important role. Whenstocks are priced at reasonable or discounted levels relative to historical fundamental norms, lowering interest rates can have a strong positive effect. Conversely, especially when stocks are overvalued relative to fundamentals, higher interest rates can be shown to have a very negative effecton stock pricing.
The effect on bonds (and bond funds) resulting from interest rate changes are more straightforward than stock pricing relationships because the effect on stocks at any given time depends on stock price levels. The effect on bonds is direct: Lower rates create higher bond prices, and higher rates result in lower bond prices. The effect of rate changes on bond prices can be more dramatic than many investors realize, with the greater price shifts associated with longer maturities. Read the rest of this entry »
In the published common stock portfolio modeling the Continuous Full Investment portfolio models were included to function as a control to allow objective comparisons with the market timing models.
Although intended as a control, allowing demonstration of the validity of the timing technique, the Continuous Models have significantly outperformed the broadly based popularized market averages. The reasons for this superior performance are twofold. First, the rigid requirements for stocks to qualify for the Master List results in the stocks comprising the Continuous Models to be of usually superior fundamental quality, thereby giving the group an upward bias relative to the overall market. Second, the Continuous Models change positions in a gradual, relatively slow process in which new positions are selected that are among the most discounted (low-priced relative to the others) on the list. In effect, a rotational process adds those that have become more discounted and deletes those less discounted. Read the rest of this entry »
Two things must be kept in mind when establishing a long position in this kind of hedge. First, since Treasury bond futures contractsrepresent face value of $100,000 worth of Treasury bonds, the investor will want to go long approximately $100,000 worth of closed-end bondfunds. When it comes to trading closed-end bond funds, I do not recommend buying more than 2000 or 3000 shares of a single fund for a short-term trade. That is why we would go long several different closed-end funds, representing positions of from $31,000 to $34,000 and amounting to approximately $100,000. That $100,000 long position offset the short position of 1 September U.S. Treasury bond futures contract at 100.18, priced at a 7.943 yield.
On February 10, 1978, with the Dow Jones Bond Average down to 89.79, two significant changes had taken place since we established our theoretical long and short positions: (1) The long positions in the bond funds had become profitable, and (2) so had the short position in the Treasury bond futures contract. For example, JHS was selling at 175/8, up from 167A; DBF was up to 165/8 from 161/2; and PAI had gone from 135/8 to 1334. The net asset values of all three funds had declined but the discounts, as predicted, narrowed more than the decline in net asset values, resulting in the profits. Read the rest of this entry »
In the common stock investment techniques, the most obvious hedging strategy might be to be long the stocks that are relatively discounted and sell short those that appear most overpriced. However, the process is not so simple.
Because of the composition of the Master List, the stocks as a group tend to do significantly better than the market as a whole. Consequently, although the long positions have significantly outperformed the broadly based market, the short positions, if sold, will likely provide lesser returns than the overall market.
It is because of the Master List’s positive bias that in hedging accounts Drach utilizes writing index call options as a substitute for the short side. This substitution both eliminates the effect of the Master List’s upside bias that would be experienced in attempting to short Master List stocks and provides added profitability for the short side because of premium capture. As discussed in Chap. 9, the method of going long the selected Master List issues and proportionately shorting (selling) index call options is a lethargic process, which has so far produced a constant annualized return of about 15 percent irrespective of overall market conditions. Read the rest of this entry »
One issue that has elicited different responses is the role of currency risk in overall risk and return. Currency risk has been accounted for in all of the evidence presented. So the existence of currency risk will not reduce the benefits of investing in foreign markets. Rather, the question is whether managing currency risk will improve the gains from international investing.
While the reduction of any kind of risk is good, there are two issues that must be considered with regard to currency risk. First, the correlation between currency risk and stock market risk is close to zero. That means that currency changes and stock returns are independent of one another. Though both currency risk and stock market risk contribute to the total risk of a portfolio of foreign stocks, the contribution of currency risk to the total risk is not very large because of the zero correlation. On average, currency risk contributes less than 20 percent of the total risk. Read the rest of this entry »
Traditional finance theory is based on actions of rational investors who can process information efficiently in a timely, unbiased manner and consistently make informed, value-maximizing decisions. However, as mentioned above traditional finance does not assume that all, or even most, investors are rational. But it does assume that irrational investors will be driven out of the market by smart, rational investors.
Behavioral finance theorists question the primary assumption of rational investor behavior. Based on concepts and models developed by cognitive psychologists, they claim that psychological forces prevent decision makers from acting in a rational manner. There are two basic themes of behavioral finance: heuristic-driven bias and frame dependence. Other characteristics of irrational behavior can usually be deduced from these themes.
The term heuristic refers to a rule of thumb that is developed by an individual based on trial and error. Note that the rule of thumb is developed not by scientific reasoning but simply on the basis of one’s own experience or knowledge. Read the rest of this entry »
Empirical evidence suggests that stocks experience momentum and reversals in returns depending on holding periods. Generally, there is momentum in short-term returns of about one month and also in the medium term of about one year, but reversals in longer periods of three to five years.
The most successful momentum strategy is to buy stocks that have performed the best over the past three to twelve months, and short-sell stocks that performed the worst over the same period. If these positions are held for the next three to twelve months, the positions generate an abnormal return of about 12 percent per year. Momentum strategies seem to be adopted extensively by mutual funds and other institutions.
Over longer periods, studies find that the returns reverse, that is, past winners become losers if held for three to five years and past losers become winners. According to long-term studies, 25-40 percent of the future return is predictable based on past returns.
Unlocking Value Around Expiration of IPO Lockups
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Posted on February 9th, 2008 in IMF | 3 Comments »
Whatever the explanation for the forward rate bias and whatever the reason for its persistence, we hope that the forward rate bias will continue to exist well into the future. Armed with this evidence, how can tradable profits be realized? The easiest way to trade the forward rate bias is to use currency futures. Futures contracts can be easily bought or short-sold, are easy to cancel, and have low trading costs. On the other hand, forward contracts are restrictive and difficult to cancel. The pricing of forward contracts and futures contracts is almost identical, so the trading profits will also be equivalent. The trading strategy consists of buying the currency with the highest interest rate and unwinding the position a month later. A one-month holding period is chosen because the forward rate bias is most prominent for shorter periods. The following steps are taken in choosing and executing the strategy. Read the rest of this entry »
To a certain extent, all investors react to good or bad news regarding the market. Investing gluttons, however, overreact. They are so hungry for action, they respond to the rumor of a merger or the hint of regulatory move by buying and selling. They become so worked up at the hint of bad news involving a stock they’re holding that they reflexively sell; they become so eager for profit at possible good news that they immediately buy.
The irony is that these gluttons think they’re getting a jump on the market, but in reality, they’re lagging behind it. Stocks can often move before the first trade by 5 percent on good or bad news. As a result, investors that use good or bad news as a trigger for a trade usually are dealing with unfavorable price movement. They deceive themselves into thinking that by reacting quickly to a news report about a stock or a broader economic trend, they are going to get a jump on other investors. In reality, they are lagging behind the market as well as other investors who make less frequent but more strategic investing decisions. Read the rest of this entry »
1. Lose Money
Like Maria, most gluttons rationalize their investing behaviors. They equate action with money: You’ve got to play if you want it to pay. This may be true if you are a trader in Chicago Board of Trade, but for the rest of us, frenetic investing usually results in losses rather than in wins. Gluttons invest burdened by four weaknesses that they may be unaware of or that they may discount. Let’s examine these four vulnerabilities and why they should not be discounted: Read the rest of this entry »
It may be that as you look at the previous section and clearly identify yourself as a greedy rather than as a realistic investor, your response is, “So what?” You may rationalize this investing behavior as crucial to your success. You are aggressive, confident, and willing to take risks; you made a significant amount of money in the market in the past, and you intend to do so in the future, and the only way you know how to do so is by thinking big and investing like a big-time player.
In fact, big-time investors are big-time precisely because they aren’t greedy. They are highly successful because they understand the way the market works, do their homework, analyze their options carefully, and then make decisions with both short-term and long-term results in mind. The greedy investor, on the other hand, gets into all sorts of financial trouble because his greed is based on an unrealistic view of the market. Read the rest of this entry »
Greed is one of the most difficult sins to manage because it is always there. We invest to make money, and every promising investment raises the possibility of making a significant amount of money. We wouldn’t be human if part of us didn’t dream a bit about what might be. Good investors, though, keep that part of themselves in a controlled, isolated environment. If you are particularly vulnerable to the sin of greed, you’ll do likewise. Specifically, you’ll do some or all of the following:
- Invest slowly, knowledgably, and logically. Speed, ignorance, and reflex are the greedy investor’s enemies. Force yourself to move relatively slowly before making an investing decision, even when you’re certain that even a moment’s delay could cost you thousands. In the vast majority of cases, delaying your decision for a short period of time won’t hurt. In most instances, it helps because it gives you a bigger window of time in which you can think, reflect, learn, and talk about an investment. Greed preys on people who just react. When I say invest knowledgably, I mean do your homework. Learn about the fund’s or stock’s performance historically. Compare the fund or stock to the appropriate index or benchmark. Read as many reports as you can related to the investment. Don’t worry that your delay makes you spend an extra 50 cents a share because in the long run it won’t make a difference. Finally, logical investing means reasoning out your investment decision. When you hear a great tip or read something that makes you believe you’ve found a great fund that will make you millions, step back and write down the logical steps that have led you to this conclusion. Specifically:
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Here the problem is lusting after a given investment even before it has proven its worth. For many reasons, people get it in their heads that a stock or fund is going to take off, and they buy too much too quickly. It is like falling in love at first sight. Suddenly, they have a singular focus and ignore everyone and every thing besides this one object of lust.
For instance, you subscribe to an investment newsletter, and you swear by it. In recent months, it has been right on the money with its recommendations, and it seems as if the newsletter author has the inside track on the market. Perhaps you recall George Gilder and hi Gilder Technology Report. People made a great deal of money in the late 1990s investing in the tech companies Gilder recommended. In fact, hi; picks were like self-fulfilling prophecies: If George picked it, the stock would invariably rise. Of course, by late 2000 just about all the tech stocks went down and people who took Gilder’s recommendations as gospel lost a lot of money. Read the rest of this entry »
Sooner or later, the market humbles everyone. This doesn’t mean you should approach investing with fear and uncertainty, but a wise investor recognizes that even the pros make mistakes and that a willingness to cut.
It losses quickly and absorb and analyze information will serve him well. Walking the fine line between humility and confidence—and between pride and self-questioning—can be difficult for everyone, but especially for investors guilty of this sin. To make it a bit easier, try following these steps:
1. Make a concerted effort to seek advice and knowledge, and try to take pride in your ability to discern useful from useless information.
As a professional investment advisor, I experience moments when I wonder if it’s worth it to seek additional information and opinions. After all, I’ve been investing for many years, I’ve been very successful, why not just trust my experience and instincts to guide my recommendations. In these moments, I remind myself of a few simple facts: Thousands of U.S. stocks are traded on various exchanges; adding in foreign markets and just considering equity and fixed income vehicles, an infinite number of ways to build a portfolio exist. Read the rest of this entry »
