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A red-hot deal on blue-chip stocks

Some closed-end funds are trading at discounts of 20 per cent or more to their breakup value

Here is an opportunity investors should salivate over: Buying $1 worth of stock for the bargain basement price of 70 cents, or even less.

Sound too good to be true? Not if you look at one of the more obscure areas of the Toronto market, a group of securities known as closed-end funds.

Closed-end funds resemble their better-known cousins, mutual funds, but with a twist. Closed-end funds trade on a stock exchange just like the shares of ordinary companies. They generally aren't immediately redeemable into cash the way that a mutual fund unit is. That means they often trade at levels well above or well below their breakup value, or the amount of money available for distribution to owners if the funds were wound down and the assets liquidated.

Consider United Corporations Ltd., a closed-end fund chock-a-block with conservative, blue chip names, many of them selected by the investment pros at famed money manager Jarislowsky Fraser. Yet its shares trade at a 31-per-cent discount to liquidation value, in effect offering investors the fabled $1 worth of stock at a price of only 69 cents.

Urbana Corp., a fund that invests in the shares of stock and commodity exchange operators, does even better. It trades at a whopping discount of 42 per cent to its breakup value.

Urbana and United Corporations aren't isolated cases of extreme undervaluation. Fully 22 of the more than 170 closed-end funds on the Toronto exchange trade at double-digit discounts to their liquidation value. Among them: CMP Gold Trust, Copernican British Banks, Canadian World Fund, Economic Investment Trust, Canadian General Investments and Coxe Commodity Strategy Fund.

For investors, finding funds available at discounts is easy because there are so many of them. The full list of funds, and the comparison between their market price and breakup value, is published on The Globe and Mail's Globe Investor website.

The big question to answer before plunking money down in them is whether the discount is justified, and whether factors exist that could make the discount narrow, preferably through a rising share price.

Those involved in the closed-end fund business say that because of the discounts, their offerings are often superior to mutual funds, which are heavily promoted for the sales commissions they generate for brokers and not necessarily because they're the best price deal for investors.

"The mutual funds industry is a very big machine, which has something that is sold to people rather than bought by people," says Michael Smedley, who manages the Canadian General Investments closed-end fund.

Mr. Smedley's CGI trades for a 25-per-cent discount. He says many savvy investors are attracted to the closed-end fund sector because it provides nimble market players the opportunity buy good assets on the cheap.

Closed-end funds are typically pint-sized, considered small caps in terms of their market capitalization. That means institutional investors with their big buying power don't generally purchase them, although many have adequate liquidity for retail investors to take positions.

Why closed-end funds often don't trade at their net asset values is a hotly debated point, but most explanations come down to the same simple demand-and-supply fundamentals that determine day-to-day security prices in general.

When markets are ebullient, closed-end fund discounts tend to narrow or move to premiums as share buyers flood in. Urbana, for instance, traded at a massive 60-per-cent premium in 2007 to its breakup value as investors clamoured to take positions in the then red hot stock and commodity exchanges sector.

During downturns, when investors flee the market, or when individual sectors go out of fashion, the discounts typically widen, often to unjustifiable extremes.

With the recent financial panic cooling interest in the shares of exchanges, Urbana, the former market darling with a huge premium, now trades at the largest discount available on the Toronto market.

Over the last three years "exchanges have been just totally brutalized," says Thomas Caldwell, Urbana's president.

The bulk of Urbana's investments are in shares of NYSE Euronext, the operator of the New York Stock Exchange, and commodity exchange operator CBOE Holdings Inc., two safe, liquid investments. Mr. Caldwell says investors would be crazy to buy the shares of the exchanges directly when they can buy them through Urbana "at a monster discount."



Here is a closer look at four of the more interesting closed-end funds (discounts in brackets) on the TSX. For a look at some other closed-end offerings, visit

Canadian General Investments (25 per cent)

and Canadian World Fund (32 per cent)

These funds are controlled by the old money Morgan family in Toronto through substantial holdings of the shares outstanding.

In an interesting development, the Morgans took private Third Canadian General Investments, another closed-end fund they controlled, last year at a substantial premium to the market price. Of the family's two remaining funds, Canadian World is smaller and would be easier to privatize, but CGI manager Michael Smedley cautioned "there is no indication" the family is considering that.

Even if there isn't a privatization, Canadian World might be a good bet. Over the past decade, it has handily outperformed the Morgan Stanley Capital International All Country World Index.

CGI aims to have an annual distribution equal to a yield of 5 per cent and has been grandfathered with a favourable tax treatment allowing it to pass capital gains to shareholders, according to Mr. Smedley.

Mr. Smedley says offshore investors have been piling into CGI, controlling 60 per cent of the non-Morgan shares, to gain a discounted price exposure to the Canadian market, which is considered a safe harbour for capital.

Economic Investment Trust (33 per cent)

and United Corporations (31 per cent)

These two funds have been around since the late 1920s and are the main investment vehicles for Toronto's old money Jackman family.

The funds hold blue chip stocks, operate with a long term buy-and-hold philosophy, and sport some of the lowest management fees (well under 0.5 per cent of assets) in Canada. Economic has a less-diversified portfolio and consequently might be more risky because it holds a major stake in the family's insurance company, E-L Financial.

The Jackmans are presumably the most knowledgeable investors in the two trusts and see a bargain.

They have regularly been buying small amounts of the stock in the two companies on open market to increase their controlling stakes. If the family were to realize the discount by taking the two trusts private and liquidating the shares in them they'd be a cool $300-million richer.

Asked whether the Jackmans have any plans to take them private, spokesman Mark Taylor said, "I can't comment on that."

He said the discounts have varied from approximately 20 per cent to 50 per cent over the past two decades.

© 2007 The Globe and Mail. All rights reserved.

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