As of July 1, there are 396 funds trading for less than the per-share value of their portfolio assets. Many of those discounts have widened to extreme levels of 15%, 20% or more. For example, RMR Asia Pacific Real Estate (NYSE: RAP) is worth $19.68, but the market is only willing to pay $14.95 -- about 75 cents on the dollar.
These pricing disconnects can be a double-edged sword. They're great for bargain hunting buyers, but can be a real pain for sellers. If an asset is worth $19.68, then that's what I want to be paid when it's time to cash out.
What History Can Teach Us
History suggests that abnormally large discounts tend to narrow over time -- RAP shareholders will be pleased to know that the fund actually garnered a premium before the 2008 selloff. But motivated sellers seldom have time to wait months, let alone years, for prices to revert back where they belong.
Fund companies understand this, which is why they have periodic tender offers. Essentially, these are windows where shareholders can tender (sell) some or all of their shares back to the company. But here's the good part: those shares don't just receive the going market price, but full face value.
In other words, sellers who take advantage can eliminate that pesky discount overnight. In the case of RAP, a tender offer would give investors the opportunity to sell their shares for +30% more than they currently fetch on the open market.
Of course, these tender offers aren't entirely altruistic. money management companies don't like to see their funds chronically undervalued (smaller asset bases mean less revenues). But they also can't liquidate profitable funds entirely -- so it's customary for tender offers to cover 20% or less of the outstanding shares. If investors try to unload more, then they typically tender on a pro-rata basis.
Real World Example
Here's a real world example of what you'll see, courtesy of Neuberger Berman.
Neuberger Berman Intermediate Municipal Fund Inc. (NYSE: NBH) has announced the next measurement period in accordance with the terms of its tender offer program. Under each tender offer program, if a fund's common stock trades at an average daily discount to net asset value (NAV) of greater than 10% during a 12-week measurement period, the fund will conduct a tender offer for between 5% and 20% of its outstanding common stock at a price equal to 98% of its NAV determined on the day the tender offer expires. The fund has determined that its next measurement period shall commence on February 19, 2010 and end on May 14, 2010.
Pretty straightforward -- if the fund stays an average of 10% or more underwater for too long, then the company will step in and purchase up to 20% of the shares from interested investors at 98% of NAV. (Incidentally, the fund traded at a smaller discount during the measurement period, so no tender offer was extended).
From time to time, one of our portfolio holdings will be the recipient of a tender offer. In most cases, we decline to participate and would prefer to stick it out for bigger gains over the long haul. But sometimes the announcement alone can provide a spark. And for investors that are ready to sell for one reason or another, these offers can provide an advantageous exit point.