Central Securities Presents Rare Investment Opportunity
Realizing a huge capital gain has put the share price and discount in the spotlight.
Central Securities (CET) is, perhaps, one of the quaintest closed-end funds, or CEFs, that you'll ever come across. This wasn't always the case. On Oct. 1, 1929, the firm began operating as a closed-end investment company in what was perhaps the most inauspicious launch of a fund in history: Black Thursday, Black Monday, and Black Tuesday all occurred within a month. Somehow the firm persevered. And, perhaps, the experiences of its early days still, somehow, influence the culture.
It is, after all, a rather sleepy equity CEF in this day and age. There is nothing that most investors would consider to be excessively risky or controversial about the fund. There are no covered-call overlay strategies. There is no leverage. There is no inflated, return-of-capital-fueled distribution rate. Instead, there is a portfolio stocked with blue-chip equities, such as J.P. Morgan Chase (JPM), General Electric (GE), and Walgreen (WAG). The portfolio managers are value-oriented investors who tend to hold securities for years, if not decades. In the past five years, the portfolio turnover rate exceeded 10% only once--in 2008 when it jumped to 11.04%. There has really been little to note about this fund for years, as it steadily went about its business, except for its discount. And that's where things could get very interesting very soon.
The Reason for the Persistent Double-Digit Discount
At Morningstar, we have a massive database on CEF information. For Central Securities, our historical data on discounts goes back to 1980. A lot has changed since then, especially for closed-end funds. But, even if we go back to the summer of 2003, which gives us 10 years' worth of data, Central Securities has never traded with a discount narrower than 4.7% since then. In fact, during that 10-year stretch, it has traded with a discount between 4.7% and 26.5%, averaging 15.7%. That's pretty remarkable, even for an old-school equity CEF. Most CEFs will trade with both a premium and a discount over a market cycle. So, why have investors shunned the shares?
Most equity-oriented CEFs that do not have an income component trade at discounts. Adams Express (ADX) is currently trading at a 14.3% discount. General American Investors (GAM) is trading at a 14.0% discount. Tri-Continental (TY) has a 13.3% discount. In this light, CET's three-year average discount of 17.6% looks fairly ordinary. Such funds tend to trade at these discounts because they have unrealized capital gains that, when realized, will be passed along to investors. New investors are facing tax risk on those as-yet unrealized gains and, therefore, are unwilling to pay full freight to buy the funds. Hence, the deep discount persists.
Mike Taggart does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.