themarketvalueofthesharesinaclosed-endfundisgreater
orlessthanthemarketvalueofthesecuritiesownedbythe
fund.Forthesefirms,itisappropriatetoattachadiscountor
premiumtothemarketablesecuritiestoreflecttheircapacity
to generate excess returns on these investments.
Aclosed-endmutualfundthatconsistentlyfindsundervalued
assetsanddeliversmuchhigherreturnsthanexpected(given
therisk)shouldbevaluedatapremiumonthevalueofits
marketable securities. The amount of the premium will
dependonhowlargetheexcessreturnisandhowlongyou
would expect the firm to continue to make these excess
returns. Conversely,aclosed-endfund thatdeliversreturns
thataremuchlowerthanexpectedshouldtradeatadiscount
onthevalueofthemarketablesecurities.Thestockholdersin
thisfundwouldclearlybebetteroffifitwereliquidated,but
that may not be a viable option.
ILLUSTRATION 10.6: Valuing a Closed-End Fund
The Pierce Regan Asia fund is a closed-end fund with
investments in tradedAsian stocks,valuedat $4billion at
today’smarketprices.Thefundhasearnedanannualreturn
of13%overthepast 10 years,butbasedupontheriskinessof
itsinvestmentsandtheperformanceoftheAsianmarketover
the period, we would have expected it to earn 15% a year.
30 Looking forward, your expected annual return for the
Asianmarketforthefutureis12%,butyouexpectthePierce
Reganfundtocontinueto underperformthemarket by2%
each year (and earn only 10% a year).
Toestimatethediscountfromitsnetassetsyouwouldexpect
toseeonthefund,letusbeginbyassumingthatthefundwill