The Coup de Grace

What could better than buying an asset class down 70-80% right before a 50% jump? What if you could buy it at a 30-40% discount to its true value?

Well, about a week ago, I was doing just that in the Closed End Fund space. Closed End Funds are funds offered to the public just once (as opposed to Open End Funds, which offer additional shares as demand for the fund increases or shrinks as shares are redeemed). Investor's appetite for risk,in the open-ended fund space is reflected by the net purchases or redemptions made by investors as a group; fund managers must then either a) use cash balances in the funds to meet redemptions or b) sell holdings in the fund.
 
In the closed-end space, investors cannot redeem shares; instead, their views are reflected via the shareprice, which trade just like common stocks on an exchange, by buying/selling the shares above or below their NAV (Net Asset Value or liquidation value).

Most of the time, shares are offered mostly to retail investors with egregious sales credits at an 8% premium to NAV at their initial public offering (the premium is due to large underwriting fees). This is most definitely a “yield to broker” trade; after all, who would want to buy a bunch of stocks or bonds at 108% of their liquidation value on the first day of trading?

Much of the time, shares eventually find a home at a discount to NAV, sometimes as much as 30-40 % below liquidation value. Indeed, this happened a couple of weeks ago, particularly in the Real Estate Investment Trust (REIT) sector in closed-end funds. I found this particularly in funds managed by Cohen and Steers, known as one of the best REIT managers out there. But when everything you own is down 60-70% in a year, and there's a 30-40% discount to the already depressed NAV, I was able to buy assets trading at a whopping 90% below their IPO price.

I have already sold some of these, as they jumped as much as 50-75% in just a week”s time (I bought very small amounts, unfortunately, but the funds are 33% leveraged - and I'm no fan of leverage). The risk/reward ratio, in proper doses, was wonderful.

As my friend Peter likes to say, I'm “renting/leasing” these securities; they're merely trades in the context of a structural bear market and recession that I believe will last into the 2010-2012 timeframe.

RLF (Cohen and Steers Advantage Income Realty Fund)

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RLF versus NAV Since 2003

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