Increase Your Profits by Using Closed-End Funds to Play the Oil Price Recovery

Harry Domash |

oil.jpgOver the last year or so, crude oil prices have tumbled from around $100 per barrel down to the low $40 range. Consequently, the share prices of not only oil exploration and production companies, but everything else even remotely connected to the energy industry, have followed crude oil prices down.

Many analysts are predicting that oil prices could touch $30 per barrel before they bottom out. But the fact is, a year ago, few, if any, saw the price drop coming, and only two or three months ago they were forecasting that prices would stabilize in the $50 to $70 per barrel range.

Thus, it is equally unlikely that many of the talking heads that you see on TV will predict the turnaround before it actually happens.

I’ll leave it to you to determine the timing, but closed-end funds should be your vehicle of choice when and if you do decide to get back into energy. Here’s why…

Closed-end funds are similar to conventional (open-end) mutual funds, but with one major difference: Rather than selling and redeeming shares as needed, closed-end funds sell a fixed number of shares when launched. After that, the fund trades just like a stock. Buyers purchase from existing shareholders, and shareholders must find a buyer when they sell.

Because they create and redeem shares as needed, open-end funds always trade at their net asset value (NAV), which is the per share value of the fund’s assets. But that’s not the case for closed-end funds. Because their share prices reflect the balance of supply and demand, they typically trade either above (premium) or below (discount) their NAVs.

They trade at premiums when their market sector is in favor with most market players, and at discounts when it isn’t. Currently, as you might imagine, most energy-focused closed-end funds, which in normal markets trade more or less at their NAVs, are trading at discounts of 15% or so.

That creates an unusual profit opportunity that isn’t available if you buy individual energy common stocks, or even with ETFs, which always trade close to their net asset values.

For instance, say that you purchase an energy-focused fund trading at a 15% discount, and then crude oil prices start moving up. If the market believes that a long-term price recovery is at hand, the energy sector should move back into favor, and energy fund discounts to NAV would shrink or disappear altogether. Thus, besides the fund share price gains resulting from the share price appreciation of its holdings, the shrinking discount would move fund share prices up another 10 to 15%.

Two Funds to Consider if you Want to Follow this Strategy

The first is a relatively conservative play, and the second is more of a walk on the wild side.

Kayne Anderson Energy (KYE) : Holds mostly oil and natural gas pipelines, which are currently out of favor, but should be profitable regardless of whether oil and gas prices move back up or not. KYE is currently trading at a 16% discount to NAV compared to a small premium or discount (0-5 percent) during normal times. KYE is paying a $0.485 per share quarterly dividend, which equates to a 12% yield ($16.20 recent price).

Cushing Royalty & Income (SRF) : Holds oil producers, energy pipeline operators, oil drillers, etc., but it overweights small-cap oil producers that have the most to gain should oil prices spring back up, and the most to lose if they don’t. It’s trading at a 17% discount to its NAV versus a small (e.g. three percent) premium during normal years. It’s paying a $0.039 per share monthly dividend, which equates to a 13% yield based on its $3.60 recent share price. However, that dividend could disappear should oil prices drop to $30 and stay there.  

I don’t have any special ability to predict oil prices. Use these tools at your own discretion. 

For tips and information on the best utilities and dividend stocks from Harry Domash, please check out Dividend Detective. 

 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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