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Closed-end funds: Outside the mainstream

They offer some strong alternatives for people willing to step away from the clutter of the fund industry, ROB CARRICK writes

Dare to be different -- check out a closed-end fund today.

Closed-end funds are the not-ready-for-prime-time cousin of the mutual fund. There's not much information available for researching them, plus they're idiosyncratic and demand some finesse from an investor. You also need a brokerage account to buy them because they trade like stocks.

And yet, closed-end funds offer some strong alternatives for people willing to step away from the clutter of a mutual fund industry that now offers 5,968 different variations.

In the market for a conservative bond fund? Canada Trust Income Investments has low fees, a good safety profile and regular monthly payouts that yield about 4.6 per cent on an annual basis.

A proven equity fund, perhaps? Canadian General Investment Trust has clobbered the S&P/TSX total return index over the past 25 years, and as a bonus it pays a quarterly dividend.

Seven years ago, only two dozen or so closed-end funds traded on the Toronto Stock Exchange. The number has grown to 180 or so as of late, mainly thanks to a proliferation of closed-end products that hold diversified portfolios of income trusts. Some of the most interesting closed-end products are among the oldest, however. While most of the fund products on the market now weren't around five years ago, some closed-end funds predate the Great Depression.

Before we look at some of these products, let's review some basics about investing in a closed-end fund. Two key benefits are lower fees than traditional mutual funds, and the ability to remain fully invested in the market at all times.

A regular mutual fund must keep cash on hand to cover redemptions by unitholders. A rush of redemptions in a down market may cause a mutual fund manager to sell some holdings he'd otherwise keep, a problem not encountered by closed-end managers.

Here are some other points to ponder.

Mind the risk: Closed-end funds may use aggressive strategies that the vast majority of mutual funds cannot, including investing with borrowed money and short selling. Check the prospectus for details.

Mind the gap: A few closed-end funds in hot sectors may trade at a premium to their net asset value, but the vast majority can be bought at a discount. Keep your eye on the size of the discount and try to buy when it's bigger rather than smaller.

Mind the pitfalls: Closed-end funds can be thinly traded, which means you could have trouble getting a good price if you had to sell in a falling market. Also, day-to-day price gyrations can be significant.

Mind the details: Closed-end funds typically have a limited lifespan and, as they get closer to the end, their discounts may disappear.

Now, let's examine a few obscure closed-end funds. The first is Canada Trust Income Investments, which is as good an argument as you'll ever see for investing in a bond fund rather than individual bonds.

Managed by TD Asset Management, this fund holds a conservative mix of government and corporate bonds with an average duration of about four to 4.5 years. By holding shorter-term bonds like these, the fund should be able to weather any interest rate increases in reasonably good shape.

An especially appealing thing about this 31-year-old fund is that it pays out 3.5 cents of income per unit each month, whereas bonds pay semi-annually and bond funds often pay quarterly. The yield on an annual basis at today's unit price would be 4.6 per cent, although the additional year-end distributions this fund typically delivers would make the actual yield even fatter.

"I just think this fund is an absolute gem," said John Cameron, an accountant, lawyer and money manager who has long followed Canada Trust Income. "I personally have 30,000 units. I'm happy as a clam and I sleep well."

Canada Trust Income Investments trades at a discount of about 7.4 per cent right now, but Mr. Cameron is looking for this to ease as the trust heads toward a 2008 vote of unitholders on whether to wind up the fund or continue it.

Another low-profile bond fund in the closed-end universe is Aberdeen Asia-Pacific Income Investment Co., which holds debt issued by Australia and other Asian countries. This fund was selected by the Canadian Wealth Advisor to be part of its safety-conscious portfolio of closed-end funds.

As a foreign bond fund, Aberdeen Asia-Pacific is vulnerable to increases in the Canadian dollar against other currencies. But its monthly payout of 6 cents a unit acts as a cushion by producing an annual yield of 7.7 per cent.

One of the oldest closed-end funds in North America is Canadian General Investments Ltd., which celebrated its 75th anniversary in 2005. This fund has generated a compound average annual growth rate of 13.4 per cent over the past 25 years, compared with 9.8 per cent for the S&P/TSX composite total return index.

"We've had two really explosive years of growth -- last year, net assets were up 27 per cent and the year before that, 45 per cent," said lead portfolio manager Michael Smedley. "But even if you discount those two years, we have still outperformed the index slightly over the long term." CGI's recent success may account for the fact that its discount has narrowed to 23 per cent recently from its long-term average of 25 to 30 per cent.

With its hefty 20-per-cent weighting in energy and 17-per-cent holding in metals stocks, CGI looks on the surface like many traditional Canadian equity funds. But its management expense ratio is more than a full percentage point below the Canadian equity fund average at 1.6 per cent, and it takes a more aggressive stance by using leverage. It does this by issuing preferred shares and then investing the proceeds.

There's also an effective dividend yield of about 4.75 per cent on average, which is based on quarterly payments of 6 cents a unit and an annual capital gains distribution.

An interesting point of trivia is that one of CGI's successful holdings is another closed-end fund listed on the Toronto Stock Exchange, Economic Investment Trust Ltd., which dates back to 1927, when it was sponsored by the accounting firm George A. Touche & Co. Today, Economic Investment Trust is a worldly equity fund, with about 42 per cent of its assets in Canada as of Dec. 31 and the remainder spread out through the United States, Europe, Asia and Latin America.

The Wall Street firm Sanford C. Bernstein & Co manages the international portion of the fund. The Canadian holdings are dominated by E-L Financial, a financial services holding company controlled by the Jackman family. Duncan Jackman serves as chairman of Economic Investment, while his father, Henry, sits on the board.

The Jackmans run another closed-end fund called United Corporations, which uses both Sanford Bernstein as a money manager and the respected Canadian firm Jarislowsky Fraser. Both United Corporations and Economic Investment Trust have delivered outstanding results in the past five years. While the S&P/TSX composite total return index made a cumulative 14 per cent over that period, Economic Investment Trust made 70.3 per cent and United Corporations 61 per cent. Incidentally, both funds are rated a "buy" in the Canadian Wealth Advisor newsletter.

Given the thousands of traditional equity and bond mutual funds available, there's no compelling reason to switch to closed-end funds. Unless, of course, you're an experienced investor who dares to be different.

Closed-end funds up close

Here are details on five closed-end bond and equity funds listed on the Toronto Stock Exchange:

Canada Trust Income Investments

Symbol: CNN.UN

Price: $9.05*

Discount/premium: -7.9%

1-year return**: 1.7%

5-year return***: 17.5%

Yield: 4.6%

DAILY CLOSE, CNN.UN-TSX

YESTERDAY'S CLOSE: $9.05, unch.

Aberdeen Asia-Pacific Income Investment

Symbol: FAP

Price: $9.20

Discount/premium: -3.8%

1-year return: 4.5%

5-year return: 21.1%

Yield: 7.7%

DAILY CLOSE, FAP-TSX

YESTERDAY'S CLOSE: $9.38, up 18¢

Canadian General Investments

Symbol: CGI

Price: $16.65

Discount/premium: -23.3%

1-year return: 22.4%

5-year return: 50.7%

Yield: 1.4%

DAILY CLOSE, CGI-TSX

YESTERDAY'S CLOSE: $16.60, down 5¢

Economic Investment Trust

Symbol: EVT

Price: $61.05

Discount/premium: -28%

1-year return: 17.3%

5-year return: 69.4%

Yield: 0.9%

DAILY CLOSE, EVT-TSX

YESTERDAY'S CLOSE: $62.00, up 95¢

United Corporations

Symbol: UNC

Price: $46.90

Discount/premium: -31.4%

1-year return: 10%

5-year return: 63.1%

Yield: 1.7%

DAILY CLOSE, UNC-TSX

YESTERDAY'S CLOSE: $46.15, down 75¢

Opening the door on closed-end funds

There are more than 180 closed-end funds trading on the Toronto Stock Exchange and many more listed on the New York and American stock exchanges. Here are some websites you can use to research them.

Globeinvestor.com

New and general information on returns and recent trading

Globefund.com

Information on whether a Canadian closed-end fund trades at a discount or premium, accessed through the Closed-End Funds tools.

Sedar.com

For quarterly and annual reports and regulatory filings by Canadian funds, search the public companies.

Cefa.com

Information on U.S.-listed funds through the Closed-End Fund Center.

SOURCES: GLOBEINVESTOR, GLOBEFUND

© 2007 The Globe and Mail. All rights reserved.

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