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By Mike Taggart, CFA | 10-01-2010 03:06 PM

Separating the Wheat from the Chaff in Closed-End Funds

Relative Value Partners' Maury Fertig on the qualities his firm looks for in CEFs and where he sees opportunity today.

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Mike Taggart: Separating the wheat from the chaff in closed-end funds. I am Mike Taggart, closed-end fund strategists at Morningstar. With me today is Maury Fertig of Relative Value Partners.

Maury, thanks for joining me.

Maury Fertig: Thank you.

Taggart: Maury your firm invests over half a billion dollars in closed-end funds and ETFs since May of '06. One of your portfolios has posted a 9.5% annualized return. Clearly, your firm has a good process in place. I was hoping you could kind of tell me little bit about the process, walk me through it.

Fertig: Sure, we look at the entire closed-end fund universe. There is about approximately 650 funds in the United States, and we basically screen out some of the funds that are very, very small, and very difficult to invest in, but once you're left with several hundred, what we consider liquid funds, we divide them into various categories, such as national muni fund, taxable corporate bond fund, emerging-markets funds, covered-call funds.

Taggart: So, you are trying to like separate them so you are going to compare apples-to-apples as close as you can?

Fertig: Yeah. So, now we find that it's not that relevant to compare a municipal – a levered municipal bond fund to a taxable or to even an emerging-market bond fund, or an equity strategy fund.

Taggart: Right.

Fertig: So, we try and look at them within their sub-categories and then we score them, based on a number of measures, including what is the z-score? What's the average historical discount? What the…

Taggart: Now the z-score, just so our viewers know? That's the statistical measure, it's the current discount minus the average discount over a certain time period, divided by the standard deviation of the discount over that same time?

Fertig: Right. So, it gives you a numerical, simple way of looking at, if the fund is cheap, if the discount is relatively cheap to where it's been historically.

Also, some of the other aspects, we might look at the, who the manager is? If they have a managed distribution policy, what the overall yield is of the fund, and things like what's the fee structure underlying the funds? Some funds have very nice reasonable fees, and some funds have exorbitant fees, and that also will be one of the inputs in terms of evaluating a portfolio manager.

Taggart: With your process, how much do you take leverage into consideration? How much do you take distribution rate into consideration?

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