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Using Net Asset Value to Uncover
Discounted Funds |
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Published:
August 27, 2007
Net asset value (NAV) is one of the
most important concepts in fund
investing, and for good reason --
investors who know how to use NAV to
determine a fund's fair value
actually have a tool to unearth
funds poised to outperform. Consider
this: investors can use NAV to
discover funds trading below the
actual value of their portfolios --
meaning you can pick up a fund's
assets for a discount to what they
are really worth.
But before you can take advantage of
what NAV is telling you about a
fund, you need to understand what
NAV is.
The Ins and Outs of Net Asset
Value
Put simply, net asset value measures
the value of a fund's assets, minus
its liabilities. The formula for
calculating NAV is:
NAV per share = (Market value of all
securities held by fund + Cash and
equivalent holdings - Fund
liabilities) / Total fund shares
outstanding
So if a particular fund held
$8,500,000 worth of securities,
$2,000,000 of cash, $500,000 of
liabilities and had 1,000,000 shares
outstanding, then the fund's NAV per
share would be:
NAV = ($8,500,000 + $2,000,000 -
$500,000) / 1,000,000 = $10.00
The NAV changes daily as the value
of a fund's securities, cash held,
liabilities, and the number of
shares outstanding fluctuates.
Making NAV Work for You
Traditional open-end mutual
funds and their closed-end cousins
share many common traits, but also a
few key differences. For example,
CEFs are more liquid, can use
leverage to boost returns, and don't
have to raise cash to meet
shareholder redemptions.
Of course, the most striking
difference is that open-end mutual
funds trade precisely at their net
asset value (NAV). By contrast, CEFs
can -- and often do -- trade above
(premium) or below (discount) the
value of their underlying assets.
While there will be situations in
which it is acceptable to buy funds
changing hands at a premium, it is
generally more advantageous to look
for those that are currently on
sale. After all, if the net value
for our fictional fund above ends up
at $10 per share, yet its current
market price is just $9, then
investors are being handed the rare
opportunity to scoop up $1 worth of
assets for just 90 cents.
When Mr. Market tosses a stock in
the bargain bin, it's often because
the company has suffered
deteriorating operating performance
or is facing some other obstacle.
However, this isn't necessarily the
case with closed-end funds -- many
funds with rock-bottom price tags
happen to be top-tier performers.
Because CEFs trade on the open
market, they are subject to the
whims of supply and demand. As such,
there is typically a discrepancy
between price and value -- sometimes
a wide one.
There is no single reason to explain
why a fund might trade below its
NAV, but academic
studies have isolated several
contributing factors, most notably:
relative performance, embedded
unrealized capital gains, investor
sentiment,
scarcity of competing funds, the
name-brand recognition of the
manager or fund company, and the
existence of a
managed distribution policy.
Regardless of the cause, if you can
swoop in on a discounted fund at the
right time, you can reap huge
rewards.
So how do you know if there a valid
reason for a fund is trading below
its net asset value or if it is the
perfect time to pick up shares at a
discount? That's where
StreetAuthority's premium ETF Authority newsletter is invaluable. In a
recent issue, Editor Nathan
Slaughter sifted through piles of
sharply discounted funds and
uncovered the names of seven funds
poised to outperform. He also
profiled two of his favorites,
including one that has delivered
annualized NAV gains of +22.2% since
September 2003 -- well ahead of its
peer group and the S&P 500. Even
better yet, this same fund is also
trading at a 10.5% discount to its
NAV! To
learn more about The ETF
Authority, including how to
access this article on discounted
CEFs, please visit this link. |
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