How to Invest at a Discount, Part 1

Berkshire Hathaway is the fabled kingdom of value investments, and famed investor Warren Buffett is its monarch; he manages (or supervises) an enormous portfolio of public and private companies including GEICO, Fruit of the Loom, and Dairy Queen.  It's hardly a coincidence that he's been able to accumulate $44+ billion to put to work in the Gates Foundation;  he's d*mn talented at allocating capital. 

Berkshire isn't cheap, however; the stock has never split, and a class "A" share (NYSE:  BRK.A) sells for a lofty $90,000 or so.  A class "B" share (NYSE:  BRK.B), which is 1/30 as valuable and has slightly different voting rights, goes for a mere $3,000.   This is out of reach of most small investors.   The other problem is that, even if you scrape together $90K for an "A" share or $3K for a "B" share, you're still paying retail:  you pay 100% of the market value when you buy. 

If you loved paying retail, you wouldn't be reading this.    You're asking yourself, "Mycroft, I know your methods.  Is there a buy-one-get-one-free coupon for Berkshire Hathaway stock?   Or a credit card that gives a 5% rebate on Berkshire Hathaway purchases?"

Sadly, no.   There IS  a way to get Buffett at a discount, however -- by purchasing shares of a closed-end mutual fund that invests in Berkshire Hathaway. 

Unlike an open-end mutual fund (which is the format that most people are familiar with), closed-end funds trade like stocks; you buy from a seller, using a broker, and sell the same way -- just as if you were buying IBM.  (See Wikipedia for a longer explanation.)

Now for the rub:  because the price of the fund is determined by supply and demand for the fund itself, not just by supply-and-demand for the stocks it holds, the fund's price may be different from it's net asset value (NAV).  Frequently, closed-end funds trade at a discount to their NAV.  Thus, it's possible to buy $1 worth of assets for $0.90 or less.  [The reason why these discounts persist is a large area of research in finance, despite evidence that purchasing at a discount beats the S&P 500 over time by 4-5% annually -- as shown by Thompson (1978), Anderson (1986), and Brauer (1988).]

Which brings us to our main story.  Once upon a time, there was a little closed-end mutual fund called Boulder Total Return (NYSE: BTF).  Several years ago, the managers apparently realized that Warren Buffett was better at picking stocks than they were.  (This realization may seem obvious, but it shows tremendous self-awareness and modesty, two qualities sorely lacking in many finance professionals!)  They invested about 1/3 of their portfolio directly into Berkshire Hathaway, and even more into Berkshire-like stocks such as Wesco Financial. 

The market HATED this idea.  "Who are these guys, anyhow, who are confessing that this Omaha fella is better than they are?  And why are they charging us a management fee while confessing that they don't know how to pick stocks?"   Investors stampeded out of the fund, demand for the fund plummeted, and the fund's price dipped well below Net Asset Value.

The funny thing is that, once these investors had rushed for the exits, the fund was actually very attractive to new investors -- and, in Mycroft's opinion, remains so today.  The fund's holdings seem sensible, and getting Warren Buffett at a 15% discount is nothing to sneeze at as a buy-and-hold opportunity. 

Think about it.  You can see BTF's holdings (updated quarterly) and discount (updated weekly) at www.boulderfunds.net.

Disclaimer:  Mycroft owns shares of the Boulder Total Return Fund and periodically purchases more.  This information is intended as a suggestion for your consideration, not advice.  Please do your own due diligence before investing. 

Comments

[Douglas Knight]

"The reason why these discounts persist is a large area of research in finance."

If you don't have an explanation, better yet predictions, it's a mistake to try to take advantage of it. What's the point of buying at a 15% discount if you have to sell at that same discount?

If the value of the stock were its dividends, a discount would be great, even if you eventually have to sell at the discount.