Most closed-end funds trade at a premium or discount to their net asset value (NAV) for various reasons and can offer excellent investment opportunities. Locking in a high-yield payout in a discounted fund can make for some exciting total returns.

Yet some investors buy into a popular closed-end fund that is trading at an enormous premium to its NAV. Why would anyone pay up to 25% for shares of a hot closed-end fund when they could buy that same basket of stocks or bonds from their broker at real market value? It's a bit insane.

Continue reading High-Yield Sin #2: Paying Big Premiums over Net Asset Value

High-Yield Sin #2: Paying Big Premiums over Net Asset Value originally appeared on BloggingStocks on Sat, 27 Feb 2010 13:00:00 EST. Please see our terms for use of feeds.

A recent Wall Street Journal article blared Fast-Money Crowd Embraces ETFs, Adding Risk for Individual Investors. The article focused on the imperfection of exchange-traded funds as tracking devices for the indices whose performances they seek to mimic. The problem is that, because ETFs are traded like stocks, they go up and down based on supply and demand for the shares themselves. Traditional index mutual funds are simply adjusted at the end of each day to reflect the net asset value of the underlying stocks. As the article says:

The funds also are heavily used by the fast-money crowd such as hedge funds and big Wall Street traders. Combined with the effects of a 24-hour market and the unusual inner workings of ETFs, that trading can distort prices on days such as Feb. 27 and March 13 when the market swooned. Some investors who sold amid the turmoil got significantly less for their ETF shares than the underlying assets were worth.

It's quite true that this is a disadvantage of the funds -- if you decide to, like a lemming, dump your shares when everyone else is trying to as well. But history has demonstrated that panic-selling can only lead to disaster for investors. Where some might see disadvantages in the volatility of ETFs, savvier investors can profit from them. One strategy for avoiding being bitten by panic-selling in ETFs is to never buy when the price is at a substantial premium to the net asset value (the net value of the underlying securities held by the fund), nor sell at a large, one-time only discount. In funds that normally trade in a tight range around their NAV, these situations are signs of extremes in investor sentiment. When investors are dumping shares well below their NAV, that is a sign of panic.

As Benjamin Graham used to say "The secret of making money on Wall Street is to be greedy when others are fearful and fearful when others are greedy."

Panic-selling a problem for ETFs? Not necessarily! originally appeared on BloggingStocks on Sun, 08 Apr 2007 08:10:00 EST. Please see our terms for use of feeds.