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Are Europe-Focused Funds Priced for a Greek Exit?

Discounts on closed-end funds can act as a gauge of investor sentiment. 

Mike Taggart, CFA, 05/25/2012

Here we are again: It's May, so Greece must be in the headlines. The story, even with its evolving headlines, is getting rather worn--a bad television series drama, inexplicably renewed for a third season. And, even though this year's plot line is thicker than previous years', with the introduction of socialist prime minister Hollande in France and the anti-austerity Syriza party in Greece, the U.S. markets seem to be focused more on matters at home than in the past two years. Specifically, Mr. Market seems to be going back and forth on whether another round of easing will come from the Fed in the coming months. But, what about the dire warnings about the effects of a Greek euro exit that the media espoused so vociferously the past two springs and last autumn? Such cries are being voiced by some, though the market seems to be taking the "news" in relative stride.

Often, investor fear is reflected in widening discounts of closed-end funds, or CEFs. CEF holders stampede for the exits, with little regard for their fund's underlying prospects. We saw this occur last August with senior loan funds, after the Federal Reserve announced that interest rates were put on hold for a couple of years. Note that they sold their shares after the announcement, as many shares were bought to protect against rising interest rates. Essentially, those investors got in too early and dropped the shares when their fears proved ill-timed.

Discounts on CEFs invested in Europe are not showing signs of panic, or (one could even argue) signs of fear. Perhaps investors in these funds are taking a "been here before" attitude, without realizing that the stakes of the game have been raised: In the past two years, the ruling coalition in Greece was willing to agree to austerity measures in exchange for more euros; after the recent Greek elections, a government with the same austerity-for-euros viewpoint couldn't be formed. In other words, it really is different this time, and not "different" as in "better." But, if history is any guide, we likely won't see the discounts on Europe-focused CEFs gap out until after Greece announces it is leaving the euro (if it in fact does so). Investors in these funds seem to be taking the contrarian view that somehow a muddle-through solution will once again appear at the last minute, making all of the worry and hype immaterial.


  - source: Morningstar Analysts

The table above shows the CEFs with the highest percentage of assets invested in Europe, both developed and emerging, as of April 30. The only funds trading at a wider discount to their three-year average are Templeton Russia & Eastern Europe TRF and AGIC International & Premium Strategy NAI. The other funds are trading at discount levels suggesting sanguine expectations of another Greek and euro rescue.

Performance over the past year for these funds is, pretty much, as one might expect in a region falling into recession and suffering from fiscal imbalances. Notice also that--unsurprisingly to those of us who follow CEFs regularly--the funds with the highest distribution rates have the narrowest discount and only premium on the list.


Mike Taggart, CFA, is the director of closed-end fund research at Morningstar.

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