Taking Net Asset Value at Face Value

Do you remember when Dave Neubert bought shares in Countrywide because they were only a little bit rich to book value? That didn't work out too great. But now he's back to the single-indicator trade, and is buying the Morgan Stanley High Yield Fund because the Closed-End Fund Association says it's trading at at 14% discount to Net Asset Value.

Now Neubert, who's a friend of mine, is a very smart guy, and a former Morgan Stanley employee, so he probably knows something I don't. But I would caution anybody who doesn't know their onions to tread very, very carefully when looking at the NAV of bond funds. Neubert seems to take at face value CEFA's assertion that the fund's NAV is $6.72 – but how can CEFA, or anybody else, be sure? Junk bonds, by their very nature, tend to be very illiquid animals, and I daresay that a large chunk of this fund's holdings has barely traded since the credit markets slammed closed in July and August.

Now it's one thing for a Morgan Stanley fund manager to phone up a Morgan Stanley bond trader and ask him for an indicative price on a bunch of junk bonds so that he can report an asset value to people like CEFA. But it's another thing entirely for him to actually be able to sell those bonds at that price. The good news is that the fund in question is small – only $77 million – so it's probably a little more nimble than a behemoth like Pimco. But a yield of just 7.5% on assets most of which are just single-B rated doesn't seem particularly attractive to me – especially not when a large part of that yield is a function of the market discounting the value of the fund.

Before buying a fund like this, I'd want to look at a chart of the fund's reported NAV over time. When shares in the fund plunged this summer from $6.17 down to $5.25 or so, was the NAV plunging at the same time? Or were the fund's managers reporting much more sanguine figures for its underlying value than the market chaos might have suggested?

Right now, I can put my money in a federally-insured E*Trade savings account paying 5.05% APR. To compensate me for the extra risk in a junk-bond fund, given the jitteriness of the credit markets, I'd want much more than 250bp. When the yield on junk-bond funds hits double digits, then I might start getting interested. But if I'm going to be taking equity-like risk (and a look at the fund's share price certainly looks more like a stock fund than a bond fund) then I'm also going to want equity-like returns.