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This article is from the A Guide to Closed-End Funds (CEFs).

Investing in CEFs: Shrinking Discount

Apart from profitting from a direct rise in the market through the NAV of the fund, a CEF investor may also profit from a shrinking discount. Sometimes, the gains from the shrinking discount may far exceed the gains through a rise in the NAV.

Again, consider a CEF with NAV of $10, trading at a discount of 20% or $8. Suppose the market moves up substantially and, assuming the NAV tracks the market performance, the NAV doubles to $20 in a reasonable period of time (as in the example above). However, the dramatic performance of the market may have attracted a large number of investors, and the demand for the shares of the CEF now far exceed the supply, resulting in the CEF trading at a premium of 20% or $24 at the end of the period. An investor who bought the CEF at the start of this period when it was trading at a discount of 20% or $8 and exited when it was trading at a premium of 20% or $24 at the end of the period, would show a profit of 200% ($16/$8) compared to the anemic 100% rise of the NAV ($10/$10).

Some Examples

Tired of the CEF with NAV of $10 trading at a discount of 20% or $8? Well here are some real examples:

The ROC Taiwan Fund

As the chart below shows, the ROC Taiwan Fund moved from a discount of around 14% in June 1993 to a sharp premium of around 30% at the end of December 1994. During this period, the market price showed a profit of 70+% (from around $7.9 to $13.5). In the same period, the NAV of the fund showed a profit of only 22+% (from $8.8 to $10.75).

The India Growth Fund

The India Growth fund, in early 1993 was trading at a modest premium to its NAV. As market perception of the fund improved due to the economic reforms in India, the CEF moved to a steep premium of 55% in early January, 1994. During this period, the market price showed a profit of around 120% ($13 to $29). In the same period, the NAV of the fund showed a profit of only 56% ($13 to $20.25).

The First Israel Fund

The First Israel fund, as the weekly chart below shows, was trading at a wide discount of 17% in early 1993. However, the market perception of the fund changed dramatically, and by the end of January 1994, the CEF was trading at a steep premium of around 25%. During this period, the market price showed a profit of 68% (from $11.6 to $19.6). In the same period, the NAV of the fund showed a profit of only 18% (from $14 to $16.5).

 

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