We contrarian investors are often a calloused lot, when you get right down to it. The experience of contrarian, long-term investors has proved time and again that it can pay to be "greedy when others are fearful, and fearful when others are greedy," as Warren Buffett has famously said. The idea is that asset prices will rebound once peace returns to the streets and the markets.
Many contrarian investors are keen to invest in closed-end funds (CEFs) because of the discounts, which are nothing more than an aggregation of market sentiment versus underlying fundamentals. Investing in closed-end funds with large discounts is a sure sign that you are investing against the crowd--but there is more to the story.
Recently, the current unrest in the Middle East and North Africa has increased investment risk in the region. This has caused asset prices to decline and oil prices to increase. While the underlying fundamentals may rebound once unrest subsides, discounts on oil CEFs and regionally focused CEFs are not offering a contrarian investment play, but more an opportunity for risk-seeking investors to lay all of their chips on the table.
The recent turmoil in the Middle East and North Africa has catapulted crude oil prices back to the front pages after a short hiatus in which the price of gold dominated the news. Events in Libya are the latest case study in how incomplete and short-term news items can wreak havoc on a market. Although Libya is only the world's twelfth largest exporter of oil, investors (and consumers) still fear the unrest will cause a global oil-supply disruption. Earlier this week, a number of oil companies announced the suspension of operations in Libya. Not surprisingly, market fears of shortages jacked the price of oil up to more than $103 per barrel on Thursday morning (as measured by the Benchmark West Texas Intermediate crude for April delivery). Later in the day, the International Energy Agency announced that only a small portion
(approximately 1%) of global daily consumption of oil was shut down because of the unrest in Libya. Prices quickly fell to about $97 per barrel.
Below is a table of CEFs investing in oil-producing companies and/or in the securities of African and Middle Eastern countries. When comparing the current discounts with those of three years ago, we can see that none of the CEFs on this list are even close to trading at significantly undervalued levels, with the exception of Quorum Oil & Gas. It appears that investors are remaining rational through the crisis.
A notable exception is Quroum Oil & Gas Technology (OGT), which specialises in providing capital to companies that themselves provide technological solutions to the oil & gas industry. Its largest holding (at 30 September 2010) was in Strata Energy Services, accounting for just under half of the entire portfolio. Strata is a Canadian-based firm with a focus on underbalanced drilling – it’s also unquoted. In fact, the only quoted holding in the fund is Wellpoint Systems Inc (WPS.H), which was a 23% holding at 30 September 2010. Unfortunately, Wellpoint Systems appointed receivers on February 1. So the widening of Quorum’s discount is largely attributable to this one holding.
Conversely, at Africa Opportunity (AOF) the fund’s discount has tightened over the last three months, although it’s dipped from a slight premium to NAV at the end of January to a modest discount now: not surprising, given the unrest in the region. The fund invests across Africa regionally, but doesn’t disclose the spread of these investments, so we can’t see how much it’s exposed specifically to the North African countries.
The ongoing crises underscore two important facts about CEFs and their discounts. First, CEF share prices do not always diverge significantly from their underlying net asset values in times of crisis. Yes, the share prices may fall, but that is likely in tandem with fundamentals. Discounts and premiums do not have to have irrational moves during times of crisis. Second, it is imperative to consider relative valuations before investing in a CEF.
It is also an interesting exercise to flip the current situation around and consider whether the current discounts on these CEFs is reflective of investor malaise about the civilian unrest. But that is a consideration with no clear cut answer, best left to cocktail conversations after hours.
To be clear, contrarian investors seeking investment opportunities amid the unrest in the Middle East and North Africa may do well to invest now. CEFs, though, are signaling that no additional return should be expected from discount moves after events calm down.
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