Making a Closed-End Bet on Asia

NEW YORK —  If you believe that Asia’s economy is on the mend and--more important--if you can tolerate volatility and are willing to monitor an investment closely, “closed-end” funds can be an attractive way to bet on an Asian recovery.

The caveat, right upfront: Some experts think the easy money may already have been made in closed-end Asia-region funds.

Certain of the funds, notably the Japan Equity Fund, the Japan OTC Equity Fund, the Indonesia Fund and the Malaysia Fund--all of which trade on the New York Stock Exchange--have already had big run-ups in price since hitting their lows last August and September.

But other such funds, including some large South Korean stock funds and some diversified Asia-region funds, are still selling at prices that may look cheap a few months from now.

Tom Herzfeld, a veteran Miami-based manager of, investor in and newsletter publisher on closed-end funds, thinks of such funds as more appropriate to investors with a short-term trading orientation rather than to those with a buy-and-hold philosophy.

To score big, he said, you have to embrace risk and you have to be early.

How early? “We will buy on volcanoes, earthquakes, coups,” Herzfeld said. “We sell on things like peace treaties.”

Still interested? Here are some basics:

Closed-end funds are like regular mutual funds in that they are portfolios of stocks, bonds or other securities, professionally managed with a stated investment objective. As with their “open-end” cousins, they charge annual management fees and tend to make annual capital gains distributions to investors.

But there are important differences. Open-end mutual funds issue new shares whenever a new investor buys into the fund. The fund manager puts the new money to work by buying more securities or expanding the fund’s cash holdings.

Similarly, when an investor sells, the mutual fund redeems the shares, taking cash out of the fund.

The day-to-day share price of a regular mutual fund is exactly the per-share value of its total holdings of securities--the “net asset value” per share, or NAV.

Closed-end funds, by contrast, have a fixed number of shares outstanding and trade on stock exchanges like ordinary stocks.

And that accounts for the biggest difference between closed-end funds and conventional funds: A closed-end fund’s NAV--the true per-share value of its underlying investments--can differ dramatically from the market price of its stock.

In the lingo of closed-end fund investors, a fund’s stock may trade at a “discount” or “premium” to its NAV, or true value.

That gives closed-end fund investors two variables to consider when trying to gauge the prospects of an investment. Rising investor optimism about a particular country, region or industry can cause closed-end funds representing that geographic area or business sector to swing quickly from a discount to a premium, far outpacing the gain in the underlying investments.

The Japan Equity Fund, for example, has rebounded with the Japanese market in recent months--and then some. The fund has risen to a current premium of nearly 26% to NAV, after trading at a zero premium early last September.

The premium/discount factor can make closed-end funds both more rewarding and more frustrating than open-end funds.

The frustration comes when you’re “right” about a fund and the NAV increases steadily but the stock price barely budges because other investors simply aren’t interested in that fund.

A striking example came with the R.O.C. Taiwan Fund a few years ago. Between August 1996 and July of the following year, the fund’s NAV per share soared 65% as the Taiwanese stock market rallied strongly.

But the fund’s stock price rose only 15% in that period. As the NAV surged, the stock price went from an 8% premium to NAV to a 26% discount.

Episodes like that reinforce what is perhaps the No. 1 rule of closed-end stock investing: “You should almost never buy a fund at a premium,” said Gregg Wolper, international-funds editor at fund tracker Morningstar Inc.

“The key to successful investing is to target a fund, No. 1, whose portfolio will do well, and, No. 2, trades at a discount that exceeds historical norms,” Wolper said.

Currently, he recommends the Morgan Stanley Asia Pacific Fund as a well-run, diversified closed-end fund. It recently traded at a discount of nearly 18% to NAV.

Wolper advised staying away from the Thai Fund, the Thai Capital Fund and the Indonesia Fund, all of which now are trading at hefty premiums to NAV.

That doesn’t mean the stocks can’t continue to rise. But to pay current prices is like paying $1 for, say, 60 cents’ worth of stock as valued in the home market.

Investors should also be aware that in smaller-country funds, the selection of stocks is too small to provide much diversification.

Indeed, some analysts said that single-country funds aren’t appropriate for most people unless they have special ties to a region and understand it well or are clearly earmarking the fund for the speculative part of their portfolio.

All that said, many analysts still see opportunity in battered Asian funds.

Michael Porter, closed-end fund analyst at Salomon Smith Barney, said that for people with a high risk tolerance, there are some signs of an Asian economic turnaround. Personal-consumption spending appears to have bottomed out, and foreign and direct investment is rebounding in much of the area.

The Japanese are “starting to pump out a lot of liquidity, which is finding its way into its own and its neighbors’ markets,” Porter said.

One fund he recommended is the Scudder New Asia Fund, trading at about a 15% discount to NAV.

Herzfeld, the newsletter publisher, has a current “buy” rating on only three Asia-oriented closed-end funds: the Korea Equity Fund, the Korean Investment Fund and the Pakistan Investment Fund, trading at discounts of 13%, 14% and 28%, respectively.

Because of high premiums, he rated as “clear sells” the Japan Equity Fund, the Japan OTC Equity Fund, the Indonesia Fund, the Malaysia Fund and the Jakarta Growth Fund.

But while they were hot, he added, they were terrific. The Japan OTC Equity Fund, for example, had an 80% bounce over just a couple of months last fall. “As people start to believe, they try to get in the door,” Herzfeld said. “The gains off the lows can be spectacular.”

For more information on closed-end funds, try this Web site: https://www.closed-endfunds.com.

Thomas S. Mulligan can be reached by e-mail at [email protected].

Foreign Investing

The “International Investing: What Now?” panels at The Time’s third annual Investment Strategies Conference on May 22-23 at the Los Angeles Convention Center will feature some well-known foreign-stock mutual fund managers. Call (800) 350-3211 for information, or see S19