Investment Bargain Boot Camp
Closed-End
Funds
Joe Timmath
W
e all know at least one bargain shopper.
They save coupons and warranties. They
get up early for Boxing Day sales, if it means
50% off on a sleek new big-screen TV.
I take my hat off to the bargain shopper. That doesn’t mean
that I’m going to start clipping coupons or getting up early
on Boxing Day, but I’m not above a little bargain hunting
when it comes to stocks – and you shouldn’t be either.
Let me take you to a sale on stocks that I’ve been going
to for years. Along the way we’ll learn about a quiet little
corner of the Canadian investment marketplace occupied
by closed-end funds.
Closed-End Funds Versus Mutual Funds
Closed-end funds and open-ended mutual funds are
closely related, cousins I’d say.
Open-ended mutual funds are far more popular than
closed-end funds. Most, and maybe everything, you’ve
learned about mutual funds pertains to open-ended mu-
tual funds. Let’s get some terminology straight. The term,
mutual fund, is commonly used to refer to open-ended
mutual funds and we’ll follow that convention here.
Mutual funds and closed-end funds have a lot in com-
mon. Both offer investors the benefits of diversification,
professional management, clear investment mandates, and
reduced fees through economies of scale. However, there
are also important differences that are the source of the
bargains we seek. One way to understand how the two dif-
fer is to review how you buy a mutual fund versus how you
buy a closed-end fund.
Buying a Mutual Fund
Investors purchase units of a mutual fund from the
mutual fund company. The mutual fund company acts as
the distributor of the fund and stands ready at all times
(unless distributions have been suspended) to issue new units
or redeem existing units. For this reason mutual funds are
said to be “open” or in continuous distribution.
Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca
The mutual fund company sets the price for buying or
selling each unit equal to the net asset value per unit at the
end of the business day. The net asset value per unit is the
current market value of the mutual fund divided by the
number of units outstanding. Intuitively this seems fair
because the net asset value per unit is equal to the stock
market value standing behind each unit of the mutual fund.
Buying a Closed-End Fund
You buy shares of closed-end funds from an existing
shareholder through the stock exchange where the shares
trade. When a closed-end fund is first launched shares are
sold to investors via an Initial Public Offering (IPO), after
that point the fund is closed and additional shares can only
be issued through a secondary offering, which is rare.
After the IPO, shares of the closed-end fund trade on
the stock exchange at a price determined between buyers
and sellers, which can be very different from the net asset
value per share. It’s important to stress that you buy shares
of a closed-end fund from an existing shareholder NOT
from the mutual fund company. Therefore, your ability to
buy or sell shares depends on finding someone willing to
take your price in the stock market.
What are Discounts?
Whereas mutual funds trade at their net asset value per
unit, closed-end funds trade at the price set by buyers and
sellers on the stock exchange. Since the market sets the price,
closed-end funds can trade above (at a premium to) or below
(at a discount to) their net asset value per share. In practice
CEFs usually trade at a discount to their net asset value. In
some cases these discounts can be large, even over 30%.
Stated another way, if you purchase shares in a closed-
end fund at a 30% discount to their net asset value, means
for investing $7,000 of your capital you’re entitled to all
the dividends and capital gains on a $10,000 market value
of stocks.
OCTOBER 2009
 The discount also works to enhance the investor’s divi-
dend yield. This happens because the investor in the case
of a 30% discount only puts down $7,000 to receive all of
the dividends on a $10,000 market value of stock. If the
underlying portfolio, after considering fund expenses, has
a net dividend yield of say 2%, that yield would be en-
hanced to 2.8% after factoring in the purchase discount
and ignoring any commissions on the purchase.
I’ve introduced and explained closed-end funds to hun-
dreds of investors. At some point in the process many will
stop to inquire about the discount. They’re concerned that
there must be a catch. They wonder how the discount can
be so large.
Struggling to Understand Discounts
The fact that large discounts can and do occur on closed-
end funds managed by seasoned and sought-after manag-
ers has been difficult for investors to understand and aca-
demics to explain.
Investors wonder what discount they’ll face when they
sell. Academics who tend to expect markets to fit their theo-
ries of being efficient and rational are left struggling to find
an answer.
Almost all of the studies on discounts of closed-end funds
are American and it so happens that discounts, particularly
on high-quality, closed-end funds, tend to be significantly
higher for funds that trade in Canada as opposed to those
that trade in the U.S. If anything, discounts in Canada need
more explaining than those in the U.S. because they tend
to be bigger.
The articles I’ve read put forward a laundry list of “pos-
sible” reasons for the discounts including relative perform-
ance, name brand recognition of the manager, lack of li-
quidity for the shares and a host of other possible causes.
Struggling to understand Canada’s outsized discounts I
came up with what I think is a possible cause. In Canada
the distribution channels for mutual funds are fairly con-
centrated, some would say too concentrated. With all of
the money and marketing behind mutual funds it can be
difficult for a closed-end fund to get noticed.
Most mutual funds pay ongoing service fees to the bro-
ker. The standard rate for mutual funds sold on the front-
end load basis is 1% of the value of the fund. Many brokers
make the majority of their annual income from these trailer
fees. The majority of closed-end funds on the other hand
don’t pay trailer fees to brokers. Why would they? They’re
closed and not trying to sell shares.
I don’t have a problem with trailer fees because I’m not
against brokers getting paid for their work. My interest is
how the lack of trailer fees for closed-end funds could af-
fect their popularity with brokers, partially explaining dis-
counts.
Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448
Paying Attention to Discounts
Discounts are attractive but to be fair the discount works
both ways. When you go to sell shares in your closed-end
fund you’ll also have to take the market price, which could
be an even larger discount. So the discount can work for
you or against you.
As a person who has invested in closed-end funds for
years I think that this can work to your advantage. By pay-
ing attention to the fluctuating size of discounts, closed-
end fund investors can potentially enhance returns by buy-
ing into CEFs when discounts are large and attractive and
selling when discounts are smaller and less attractive.
CEFs as a Place to Manage Money
While discounts are attractive I think there is a more
basic reason to consider closed-end funds. Closed-end funds,
in my opinion, put the manager in a better position to
maximize net returns for investors than do mutual funds
for the following reasons:
• Smaller Size - CEFs are generally smaller than mutual
funds, allowing them to be more nimble.
• Intra-day Trading - CEFs can be sold (or bought) dur-
ing market hours for a known price whereas mutual funds
can only be sold (or bought) for an unknown end of the
day price.
• Closed Status - CEF managers do not have to deal with
money continually flowing in and out of the portfolio –
usually at the wrong time.
• Reduced Redemption Risk - CEF managers don’t face
the daily redemption risk necessary to fund large net-
redemptions and be forced to sell investments in down
markets.
• No Curse of Success - Mutual fund managers face the
curse of success when good relative short-term perform-
ance can attract huge new inflows into the fund making it
difficult to maintain performance.
Two Closed End Funds To Consider
United Corporations (UNC) on the S&P/TSX
The first is United Corporations Limited, which trades
under the symbol UNC on the S&P/TSX. United Corpo-
rations is a typically low-profile, closed-end fund. You may
have never heard of them before but they’ve been trading
on the TSX since 1933.
United Corporations is an investment company with a
global equity mandate. It’s only asset is a portfolio of pub-
licly traded securities. United Corporations has agreements
with two portfolio managers. Jarislowsky Fraser Limited
manages approximately 70% of portfolio, ValueInvest As-
• http://www.canadianmoneysaver.ca OCTOBER 2009
set Management S.A. through their Canadian arm, Pier 21
Asset Management Inc, manage about 25%, with United
Corporations managing the remaining legacy positions in-
house.
Both of the managers have impressive pedigrees.
Jarislowsky Fraser is well known to Canadian investors as
one of the largest managers of pension and endowment
funds in the country.
As of September 3, 2009 UNC closed the day at $46.83
trading at a discount of 25.84% to its net asset value per
share of $63.15. As with many closed-end funds UNC has
low fees with the management expense ratio for the most
recent year coming in at a paltry 4/10 of 1%, far lower
than the average mutual fund.
CERES Global Ag. Corp. (CRP) on the S&P/TSX
The second fund may be of special interest to investors
who would like to focus a portion of their investment port-
folio on agriculture. Ceres Global Ag. Corp is a publicly
traded investment company with a mandate to invest in
agriculture-related companies, both public and private.
Ceres is a newer fund and started trading on the S&P/TSX
in December 2007 under the symbol CRP.
The fund is managed by Frank Mersch of Front Street
Capital. Mr. Mersch was one of the founders of Altamira.
Mr. Mersch has an enviable record of performance over the
last 20 years in the stock market.
Shares of Ceres closed on September 10, 2009 at $5.65,
which was a whopping 37.38% discount to the underlying
net asset value of $9.023 per share.
Remember to do your homework including consulting
qualified advisors before making any purchase.

Joe Timmath, CA, CFP, Financial Advisor, Raymond James

Ltd, Vancouver, BC (604) 639-8608,
joe.timmath@raymondjames.ca.
The views of the author do not necessarily reflect those of
Raymond James. This article is for information only.
Securities-related products and services are offered through
Raymond James Ltd., member CIPF. Financial planning
and insurance products and services are offered through
Raymond James Financial Planning Ltd., which is not a
member CIPF.

Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca OCTOBER 2009