Premiums Get Out Of Hand
To judge by recent activity in some country funds, the day fund investors behave in a rational fashion has not yet arrived.
At first glance, it seems logical that people would have scrambled lately to buy shares of closed-end funds specializing in countries in Asia and the Pacific basin. Many stock markets in that part of the world suffered severe declines last year, attracting bargain-hunters as 1998 began.
But it’s not so easy to figure why buyers of some closed-end funds haven’t been more discriminating about the prices they were willing to pay.
Unlike standard open-ended mutual funds, where new shares are always available from the fund manager at a price based on net asset value, closed-end funds have a fixed supply of shares that trade in the secondary market.
The price any closed-end investor pays or receives is determined by supply and demand, and may vary significantly from net asset value, or NAV, going either to a premium above the NAV or a discount below it.
As of early February, the Indonesia Fund and the Jakarta Growth Fund both were trading at premiums of more than 100 percent. In other words, their shares were selling for more than twice the value of the investments in their portfolios.
Two Thai funds sported premiums of 92 percent and 60 percent. Three Korean funds had premiums ranging between 26 percent and 34 percent, and a couple of Japanese funds traded at premiums of between 15 percent and 22 percent.
In her newsletter Global Investing, based in New York, Vivian Lewis described this situation as ridiculous.
She points out that closed-end funds investing regionally in the Asia-Pacific sector have at the same time generally been selling at discounts to their net asset value, or at most at only small premiums.
It is possible to make money on an investment in a closed-end fund bought at a premium. But to a great extent, any purchase made that way depends on the “greater fool” theory - the supposition that down the road, when you want to sell, there will be someone willing to pay an even higher price than you paid.
That’s worth thinking about any time you are asked to pay a premium price for an investment when similar, if not identical, investments exist that can be bought on more advantageous terms.