It is well known that if there are restrictions on financial capital movements, then big gaps can open and persist between the NAV and the price of its CEF. But, in general, CEF prices tend to go to the NAV, or more generally to about a 10% discount from the CEF price. Premia very rarely persist, and large, 100% premia are especially unlikely to persist. Even if there is some eventual upward movement of the NAV, there is much more likely to be a much larger downward movement of the CEF. Still sucker bait. Barkley Rosser On Fri, 09 Oct 1998 16:53:56 -0400 Greg Nowell <GN842 at CNSVAX.Albany.Edu> wrote:
> I'm still mulling over the closed end fund issue which
> I think is more complex than my critics have given it
> credit. Let's set aside the closed end fund thing for
> a while. I don't think valuation in the foreign
> currency is entirely sensible.
>
> In the following example, let's eliminate depreciation
> for the sake of argument.
>
> Cartel Computers (CC) purchases and ships $1 m in
> computer manufacturing equipment to Indonesia. In
> partnership with an Indonesian firm a company is set up
> which issues stock in the local currency. The CC in
> combination with local capital take controlling
> interests. Their shares are not traded, but prices, of
> course, are set at the margin by the shareholders that
> are doing their thing. The firm exports computers for
> the world market and with the rupee at par $1=100r
> earns an annual profit of 15%.
>
> After two or three years a currency crisis devalues the
> rupee 50% for reasons which are exogenous to the
> activity of this firm. It continues to earn 15%.
> Because it is one of the established equities in the
> local market international traders take short positions
> in the stock and speculate against the national
> currency, so the stock declines as well, in spite of
> reasonable earnings (just like a lot of performing
> bonds have taken hits in recent days, as well as
> performing stocks in the US).
>
> Due to the combined stock and rupee depression the
> dollar valuation of the firm has fallen 75%. Inside
> that firm is $1,000,000 worth of equipment currently
> valued at $250,000.
>
> However, neither CC nor the domestic controlling
> interests put the firm up for sale for controlling
> interests (this is why Korea has balked at some of the
> equity transfer proposals to manage the currency
> collapse). They know that the firm is worth more than
> the pricng mechanism is saying it is worth.
>
> Now, the question is, how does CC look at its
> investment in this firm. It is no different, than say,
> Ford or GM with a factory in Europe when the relevant
> currency goes down 20%. The fact of the matter is if
> the firm is making profits in local terms it's not
> necessarily the case that you want to get rid of it if
> you are losing money on the exchange. Maybe you just
> want to take your local money and reinvest it locally
> (like a tariff, currency falls can encourage local
> investment). Because you know two things. One, the
> firm is viable as a local enterprise, and two, as an
> international firm, it is an asset because it is making
> something you know you can sell for more elsewhere
> (note that the currency falls have not resulted in huge
> crashes in prices here. Most of the price crashes have
> come from our export sector. In fact Asian firms are
> trying to keep US prices high to compensate lost sales
> in Asia).
>
> So if someone offers to come in and "buy this firm" at
> 25% of par, which happens to be today's price, it
> amounts to a fraud, and everyone involved knows it. CC
> may be forced tow rite down the value of its asset on
> its American books. But it's not the case that this
> firm can be bought for the nominal stock market price.
> And CC knows that at a minimum it can yank the
> productive machinery out of Indonesia and haul it back
> here, where it will be worth $1,000,000. And arguably
> if that's what the physical capital is worth in the US
> that's what the firm should in fact carry on its
> books. So this Indonesian company, in spite of stock
> prices, won't be for sale. If you want to say, well,
> the reason is there's overcapacity in computers and
> hence the assets aren't in fact worth anything, well,
> it really makes no difference. In the universe of
> overcapacity all firms are undervalued but some number
> of those firms in fact have a higher intrinsic value
> because a year or two down the line they'll be back on
> their feet. And people know this.
>
> So the point is that the stock market valuation can be
> rejected by major players.
>
> Now, in the closed-end universe, I think there may be
> something linked to this kind of divergence. Ownership
> of a % of the underlying physical capital is secured
> through stock ownership but the "real value" might be
> more closely approximated by the $ valuation of the
> assets, in spite of teh currency fluctuations. Yes,
> you could go to Indonesia and buy the same stuff
> cheaper or presumably have a broker do it for you. But
> once you do that you are in the rupee universe. It is
> possibly the case--in my confused thinking?--that the
> relative stability of the dollar valuation in a closed
> end fund is analagous to the CC company which, knowing
> that the underlying value of the physical capital is
> $1m and that the market valuation is a quarter that,
> refuses to sell at the price. The company can't be
> bought at that price nor can it be replaced with
> another company at that price. Speculative forces have
> caused it be undervalued.
>
> Something also must be added, about the weirdnes of how
> we value things by marking them to market. I have had
> shared in two analogous funds, one closed-end, the
> other open. They both hold the same kinds of assets.
> One is trading at a premium and the other is trading
> 10% below July levels. Because its value is set every
> day by tallying the sale of assets that have plunged in
> their trade among professionals, it directly reflects
> liquidity in junk. But the other trades at a premium.
> Why should this be?
>
> The answer, I think, is that prices are set at the
> margin by whoever is happening to sell--usually
> speculators--but there is another is acting rationally
> by discounting current fluctuations. Some people are
> in stocks for the 20 year period. They hold no matter
> what today's price is. If those people are in a closed
> end fund and continue to hold, it will stabilize the
> value of that fund even if the market prices underlying
> assets differently--because 20 year people and day
> traders are two different birds. In the case of LND,
> a 7.5% annual return with another 1.5% annual dividend,
> in a fund that has a 15 or 20 year history, looks
> pretty good when some funds are offering 4%.
>
> Anyhow perhaps I am mising something but I don't think
> it is as stragithforward as JBOD (offline) and Rosser
> have made out. But I could be wrong. I've been wrong
> before.
>
>
> --
> Gregory P. Nowell
> Associate Professor
> Department of Political Science, Milne 100
> State University of New York
> 135 Western Ave.
> Albany, New York 12222
>
> Fax 518-442-5298
>
>
-- Rosser Jr, John Barkley rosserjb at jmu.edu