Margin-of-Safety

The Nature of Wall Street Works Against Investors 36
Closed-end mutual funds are typically offered initially to investors at $10 per share; an 8
percent commission is paid to the underwriter, leaving $9.20 to invest. Within months of issuance,
closed-end funds typically decline in price below the initial per share net asset value (the market
value of the underlying holdings) of $9.20. This means that purchasers of closed-end funds on the
initial public offering frequently incur a quick loss of 10 to 15 percent of their investment. From the
initial purchasers' perspective the same purpose could be achieved less expensively through
existing no-load open-end mutual funds. These funds are able to make the same investments as
closed-end funds but no underwriting fee or sales charge is paid; unlike closed-end funds, they
can always be bought and sold at net asset value (NAV). 1
The 1989-90 boom in the creation of new closed-end country funds exemplifies the tension
between Wall Street and its customers. As noted in chapter 1, speculative interest in closed-end
country funds resulted in the shares of many funds being bid
far above underlying NAVs. Buying into new offerings appeared to be a quick, easy, and almost
certain way to make money. In June 1989, for example, the Spain Fund, Inc., sold at 92 percent of
NAV, an 8 percent discount. Only three months later the shares traded at more than 260 percent of
NAV and remained at more than twice NAV until February 1990. By late summer of that year the
share price once again approximated NAV, which was somewhat lower than it had been a year
earlier. This price trend is not unique; the share prices of several other country funds underwent
similar gyrations.
Investor enthusiasm for country funds was bolstered by the
sudden collapse of communism and the democratization of Eastern Europe; peace appeared to be
"breaking out" around the world. Funds were formed to invest in such exotic locales as Austria,
Brazil, Ireland, Thailand, and Turkey. Ironically, only months after the boom in issuance of closedend
country funds peaked, Iraq invaded Kuwait. The price of oil rose sharply, recession fears
mounted, and stock markets worldwide plunged. The prospect of finding new buyers who would
pay