An Open Invitation To Closed-End Funds
By Andy Serwer

(FORTUNE Magazine) – Forget about your precious tech stocks for just a second--they aren't going anywhere, believe me--and take a look at a group of stocks that I think are pretty darn interesting right now. I'm talking about closed-end country funds, and if you're like me, you've probably forgotten all about these puppies. Well, let me tell you something, there's a lot going on here. As in value, turmoil, and tumult! I had no idea.

First off, a reminder: Closed-end funds, as opposed to plain-vanilla open-end mutual funds, have a set number of shares and trade like common stocks--that is, the shares rise and fall with demand. The underlying value of the fund's assets is called the net asset value, or NAV, and a fund's stock price sells either at a premium or at a discount to NAV, which is part of what makes these guys so interesting. Now, there are 517 closed-end funds trading in the U.S., with some $123 billion in assets, and they include U.S. stocks, bonds, and sector funds, all of which seem to scream, "Why bother?" The best-known group, however, is the roughly 70 closed-end country funds. The attraction to investors is more obvious here. These funds own a basket of stocks that are a proxy for an entire country's or region's market. And they often sell at a discount to the value of the underlying assets. Besides the predictable Germany and Asia/Pacific funds, we now have the First Israeli fund, the Argentina fund, and even the Portugal fund.

And these baskets are cheap! According to Salomon Smith Barney analyst Michael Porter, who covers the country-fund market, overseas funds are down some 15% to 20% this year, with the average discount to NAV leaping from 11% to 21%. Clifford Rackson, of New York's Rackson Asset Management, says he hasn't seen these funds this cheap since 1994.

Why the drastic markdown? A number of reasons, explains Rackson. First, with U.S. equities so hot over the past few years, interest in investing overseas has waned. Second, investors are still spooked by the 1998 blowups in Asia, then Russia, then to a lesser extent Latin America--and in many cases, country and regional funds investing in these areas still trade at extreme discounts. Third, closed-end funds used to be attractive because they held stocks that U.S. investors had a tough time buying. With the proliferation of ADRs, though, that advantage has lessened. And these funds face new competition from country index funds, called iShares, which trade on Amex.

Wow! With that list of bugbears, why would anyone buy? Well, there are some behind-the-scenes machinations that could make getting into some of these funds compelling. As in shareholder activism. With the discounts so steep, Rackson says, "retail investors are gradually being replaced by value-oriented institutions, which has created an investing opportunity." Why? Because these institutions hope to force fund managers to either buy back stock or bust up the funds altogether to unlock value. It ain't easy, though. That's because management's interests are less aligned with shareholders' than in an ordinary company, Rackson says. In closed-end funds, managers own only a nominal amount of equity or none at all. Plus, those managers aren't paid on the basis of share-price performance but on the size of the fund's assets. One fund that could be living on borrowed time (good for investors!) is the France Growth fund (FRF), which is being strong-armed by a German bank looking to close up its 15% discount to NAV.

Uber-investor Mark Mobius, who runs six country funds, has been on both the giving and receiving ends of activism. As an investor, he has jawboned company management to look out more for shareholders. But with his own funds selling at a discount, he has lately been the target of some who say he should practice what he preaches and look to close the discounts! "I'm trying," he says by phone from Hong Kong, "but I'm at the mercy of the boards of the funds and the SEC, which makes it difficult to buy back shares." (If he tried harder, critics say, both obstacles could be overcome.) By the way, Mobius now favors unloved Asian economies such as those of Indonesia, Thailand, and the Philippines, in which the Templeton Emerging Markets fund has stakes.

Investors reap the most rewards, though, if the discount to the fund's NAV closes and the share price moves up. (The old double whammy!) Here, you might want to check out the New Germany fund (GF), managed by Deutsche Bank. It's selling for about a 22% discount to NAV. Some 35% of the fund is in Neuer Markt stocks--Germany's Nasdaq equivalent--so you're getting a helping of small- and mid-cap German Internet and telecom stocks at a discount. In Asia, Porter of SSB favors the Korea fund (KF), which has a huge discount and sells for ten times earnings. A nice unification play, no? Morgan Stanley's Asia Pacific fund also sports a 30% discount, which gives you a good cheap way to ride the Asia recovery.

Broadband on the Run

There's no such thing as a highflier anymore. Sure, some stocks have come back, but all of them got beat up this spring, right? Not all. Check out ADC Telecom (ADCT), a maker of equipment and software for broadband networks. The stock has gone from $35 to $80-plus this year, barely skipping a beat during those nasty spring months. Why? Well, business is exploding, and investors have liked the roughly 25 companies that ADC has gobbled up in its five-year buying spree. This is no Johnny-come-lately either. Founded in Minnesota in 1935, ADC later did business in a St. Paul brewery. Love that! Today it's become the latest darling of analysts. Stock was at $20 a year ago. It hasn't looked back since.