Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

MSCI EAFE Value Index at a 50% Discount to Growth

The battle between growth and value continues in global investment circles.

After suffering a trashing last year, value investing continues to struggle this year as global equities try to break free from the shackles of an earnings slowdown. But recent data, courtesy of Morgan Stanley Capital International (MSCI), points to some big bargains now available in its proprietary value index.

EAFE, which is Europe, Australia/New Zealand and the Far East, includes industrialized markets outside of North America. The Pacific component also includes Hong Kong and Singapore. The largest country components of the index are the United Kingdom, Japan and Germany.

According to MSCI, the EAFE Index now trades at just 11.7 times trailing earnings, 7.3 times price-to-cash-flow and pays a 3.6% dividend yield. This compares quite favorably to the MSCI EAFE Growth Index, selling at 18.2 trailing earnings, 11.7 times cash-flow and yielding 1.8%.

In the United States, the S&P 500 Index trades at 18.2 times trailing earnings and yields just 2.1% in dividends.

Compared to the MSCI EAFE Growth Index, the MSCI EAFE Value Index trades a significant 36% discount – the same differential also applies to the American broader market. But dividends for the Value Index are impressive at a 50% premium to the Growth Index and 42% more than the S&P 500 Index.

In the last bear market from 2000 to 2002, value investing actually posted a cumulative three-year gain while growth stocks got massacred.
2008 could be another great opportunity for long-term value investors seeking quality, high-yielding global companies following a big market rout since last November.

Some Closed-end Funds Offer Value as Bull Market Grays

I adhere closely to Ben Graham’s investment principles, especially buying an asset at a discount to its book-value. There’s a significant margin of safety buying a security valued less than its market price. Coined “value investing,” this style or brand of investment performance has lagged “growth” investing this year as most value stocks enjoyed a big bull market from 2000 to 2004 and then sputtered.

In the United States, closed-end funds went into new issuance hibernation in the late 1990s. But a bull market in IPOs has developed over the last few years, mainly in funds focused on dividend-paying strategies and real estate investment trusts. In London, over 200 investment trusts are available and trade the same way as closed-end funds – at a discount or a premium to their net asset value (NAV). Funds on the London Stock Exchange, however, trade in sterling.

As this bull market ages and eventually dies over the next 12-24 months, if not sooner, investors should stick to heavily discounted closed-end funds for new purchases. Rather than buy an asset or a mutual fund at net asset value, I’d be looking to buy closed-end funds – but only if they trade at a meaningful discount to their NAV. That means buying a closed-end fund when it trades greater than a 10% discount. Never buy a closed-end fund trading above NAV or at a premium.

Many closed-end funds have earned big returns over the last 12 months, especially those products in the global, regional and single-country fund sectors. I’d avoid most of these funds now.

At current prices, a host of global and domestic real estate funds trade at a big discounts to their NAV and sport dividends in excess of 8-10% following a massacre this year in REITs. Also, closed-end funds specializing in convertible securities and preferreds look attractive amid a falling interest rate environment in the United States; some of these hybrid funds trade at 10% discounts or greater, and provide an effective yield in excess of 10%.

But not all closed-end funds look attractive. I’d avoid placing new money into most of Asia, including China and India, Eastern Europe and Latin America following gargantuan rallies over the last four years. Also, avoid closed-end bond funds; most of these funds offer paltry inflation-adjusted yields and unattractive discounts.

One of my favorite closed-end funds since early October is a global mining fund trading at a 13.6% discount to NAV.

The idea of buying a basket of large-cap gold-mining stocks for just $0.86 cents on the dollar is very appealing to me at this stage of the gold bull market where major producers have lagged bullion since 2006. In September, these companies awoke from the abyss and gained more than 25% as gold prices surged above $700 an ounce and established a new floor.

In my Commodity Trend Alert, we’re long this closed-end fund and already up 14% since mid-September on what I would coin a conservative mining investment. There’s much more to come in the way of profits as gold cracks its all-time high of $850 an ounce, probably in 2008.