This week, we’ve got an overlooked, misunderstood, usually rank investment instrument. They’re called closed-end. And except for when they stink, they can net big gains at a discount.

So put aside those thoughts of whether to invest in single stocks or siren Internet funds, and do both at once by investing in closed-end funds. True, few people track them, or even talk about them. Yes, they’re basically the black sheep of the fund family. But there’s green in that thar dust bowl.

First, let’s share a defining moment. Open-end mutual funds are what the herd loves. Moooo. They’re the funds you find in the mutual fund section of your paper, they number in the thousands, and everyone from your grandmother to your 12-year-old sister invests in them. Closed-end funds are also pools of professionally managed stocks, but that’s where the similarities end.

Unlike open-end funds, where the fund company creates or eliminates shares every time you buy or sell, closed-end funds have a fixed number of shares. Open-end fund shares are sold for the value of their portfolio, or Net Asset Value (NAV), sometimes with a sales charge added. The price of closed-end shares, like individual stocks, is set by investors’ supply and demand.

Finally, closed-ends are not listed in your paper’s mutual fund section. Instead, you’ll find them listed daily with other stocks (most are listed on the New York Stock Exchange), in the weekly Barron’s Magazine. or closed-endfunds.com — awesome site, check it out.

Because closed-end prices are not fixed to the values of their portfolios, closed-end funds can trade at significant discounts to the actual value of their portfolio — i.e. with a closed-end you can sometimes buy $1,000 worth of stock for $800. Or you may have to pay a premium for a hot closed-end. Naturally, it’s best to buy closed-end funds at a substantial discount, and sell at a smaller discount or a premium. Currently, discounts are quite wide on most funds, meaning it’s probably a good time to opt for a closed-end.

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If a closed-end fund has a bad manager or is in an area that looks like it will be hard hit for a protracted period of time, stay on the sidelines regardless of the discount. But know this closed-end fund fact: All things being equal, closed-end funds see their greatest discounts when their investments are out of favor. From where we sit, that would often be the best time to take a closer look at the area anyway.

Unlike regular funds, i.e. open-ended funds, there aren’t really shareholder redemptions in a closed-end fund. This gives the closed-end manager complete confidence that he won’t have to be dumping illiquid securities and raising cash to meet withdrawal demands from jittery shareholders. That confidence means freedom to concentrate assets in promising, but illiquid securities, and to concentrate within a narrow market. For this reason, closed-end funds make the most sense as a vehicle for investing in illiquid securities, especially stocks in the smallest companies, and stocks in foreign markets (particularly emerging markets).

Taking advantage of these strengths, this closed-end portfolio is specifically designed to complement your domestic large-cap positions. Don’t have any? Consider Vanguard Index 500 (VFINX ), or the SPDR (ticker SPY ), which is basically the same thing but trades like a stock rather than a fund. You may choose to put as much as half your assets in this closed-end portfolio, which holds aggressive foreign positions and a domestic small-cap fund, all trading at decent discounts with substantial upside potential.

Closed-End Portfolio:

• 25 percent Royce Micro-Cap Trust (OTCM )
• 25 percent Europe Fund (EF )
• 25 percent Japan OTC Equity (JOF )
• 25 percent Asia Tigers Fund (GRR )

Royce Micro-Cap Trust was recently (March 14th) trading at a 13 percent discount to NAV, despite holding a portfolio that’s up 35.1 percent for the 12 months through February. The only micro-cap closed-end fund, Royce Micro-Cap’s holdings are also much smaller than those found in almost any open-end mutual fund. Moreover, Chick Royce has one of the longest and better histories of small cap management on our planet.

The Europe Fund’s NAV is up 27.8 percent for the past 12 months. That’s 10 percent ahead of the Morgan Stanley Europe index, but the fund is selling at a 16 percent discount to NAV (despite the growing discount, its share price was still up a market-tracking 17 percent for the period). Currently, this area is much cheaper than the U.S. market. In fact, Europe presents many attractive closed-end fund buys. Forget cheap air fares to London or Madrid; you can own a piece of Europe for the price of a round trip ticket. While Europe fund is one solid option, another is Central European Equity (a Germany-focused fund with some Polish and Czech weighting), and France, Germany, Ireland, Italy, Spain, Switzerland, and even Portugal have single-country funds named after them, most at significant discounts despite solid returns.

Japan OTC Equity’s NAV has gained an extremely strong 195 percent in the past year, but still trades at a generous 34 percent discount to its underlying value (the fund’s market-set share price gained 79.3%). Unlike most Japan-oriented mutual funds, Japan OTC Equity concentrates on smaller-cap over-the-counter stocks (there is an open-end option for investing in this area — Fidelity Japan Smaller Companies, FJSCX ).

Finally, Asia Tigers Fund is a promising way to hold this volatile, but high growth, area of the world economy (the fund’s top countries are Hong Kong, Korea, Taiwan, India, and Singapore). Over the past year, the manager and investors who stood their ground benefited with a 79.8 percent gain from an area that most others have shied away from. The fund is selling at a 28 percent discount to NAV, despite a long-term share-repurchase plan. The plan should tend to bring share prices up, shrinking the discount.

Sometimes it pays to go against the grain. With closed-end funds, you can be a rebel with a profitable cause.

— Posted: March 20, 2000