One type of stock investment that may present an attractive buying opportunity during November and December is closed-end country funds, allowing investors to essentially buy international stocks “on sale,” or at a discount to their net asset value.

One word of caution though: buying anything “on sale” at Wall Street means that when you sell it, you might also have to put out the sale sign.

How do closed-end mutual funds work?

They are very much like mutual funds in that they are both investment companies. The difference between a mutual fund, which is also known as an open-end fund, and a closed-end fund involves the way they are priced and capitalized. Mutual funds have open-ended capitalization. They continually issue new shares to buyers and stand ready to redeem those shares when an owner of a mutual fund wants to dispose of his shares.

Closed-end funds, on the other hand, issue a fixed number of shares then trade on the stock exchange. So when a person buys shares in a closed-end fund he does so in a normal New York Stock Exchange transaction. The seller is an existing shareholder, not the fund issuing new shares, and when a seller of a closed-end fund wants out of a position he sells it in the open market to an investor who is buying in a normal stock market transaction rather than to the fund who is redeeming them.

The way they are priced is the second difference. Mutual funds are priced based on the net asset value. You buy and sell them at net asset value if they’re no-load funds. You buy them at net asset value plus a sales charge if it’s a load fund. The price of a closed-end fund is determined by the force of supply and demand. If there are more buyers, it pushes the price from there. As sellers dominate the market place, it depresses the share value. When sellers dominate and the share price sinks, it is then trading at a discount to its net asset value, or if there are more buyers than sellers it can push the share price to a premium.

What distinguishes a closed-end country fund?

They are formed with the investment objective of investing in a security of a single country. It is a traditional and historic way that investors have sought to invest in foreign markets. It dates back to the 1800s when the English were forming closed-end funds to invest in the Argentine Republic.

It’s a very efficient way to invest in a foreign market because, unlike mutual funds which have to continually issue new shares and meet redemption, closed-end funds have a fixed capital structure and therefore the portfolio manager can invest in illiquid securities. And in many of the countries these funds are formed to invest in stocks that are highly illiquid.

How have international stocks been performing?

Most foreign markets, especially markets that single country funds are invested, have not been having a particularly good year, and consequently the discounts to the net asset values of country funds have become very wide, especially on Asian and emerging market funds. This is a cyclical phenomenon. When foreign investment is out of favor, discounts tend to widen and when foreign markets are hot and everybody wants them, many closed end funds move to premiums to net asset value.

Next year may be a much better year for country funds than the year 2000. The average foreign equity fund is down year to date. The average country fund was down about 6 or 7 percent when we measured a few weeks ago.

If the foreign markets rebound, investors can really get a two-pronged benefit, not only when the net asset values increase. Many closed-end fund managers have been adopting measures recently and have others under consideration to narrow the discounts of their funds. And if the managers themselves don’t do this, they’re likely to keep getting pushed by dissident shareholders to remedy the discount.

What are some risks associated with investing in closed-end country funds?

Exchange rates, political risks, foreign taxation issues, lack of disclosure. And in addition to those risks, the possibility that the closed-end fund discount would widen after the investor buys it. That’s a risk peculiar to closed-end funds. It’s also a potential benefit if a discount should narrow after he buys it.

Any other benefits?

They tend to do very well in January. The January effect is very pronounced in country funds, as is the depressing nature of year-end tax selling on these issues. It’s like a rubber band. In December, the rubber band seems to be stretched wide from tax selling and it snaps back in January. Going into the fourth quarter when the tax selling starts, one should pay close attention to the discounts of country funds with a view toward buying them. It’s very timely, and don’t be trigger happy, the bargains are usually the best at the end of the fourth quarter.