Mike Price sends: This is part two of the series on special situation investing. View part one here. The special situations written about here will be:

Closed-End Fund Arbitrage

Activist ‘piggy backing’

Deep, Deep Value

LEAPS

Closed-End Fund Arbitrage

Closed-end funds are mutual funds that have a limited amount of shares and trade on a public exchange (NYSE, NASDAQ) like stocks. Because of the nature of the funds trading on an open exchange they frequently trade above, at a premium, or below, at a discount, to their NAV - Net Asset Value or the value of the mutual fund at the time. Thus a smart arbitrager can find a closed-end fund trading at a discount and buy it until the gap closes, or do vice versa and short a closed-end fund trading at a premium.

However it is not that simple - if it was these situations would not exist. Some closed-end funds trade at a steep discount to their NAV, but the discount is probably deserved, as closed-end funds that underperform or have always traded for a discount should not be bought without a foreseeable catalyst - like activists - that will propel the fund back to it’s NAV.

Currently my favorite in this category is the Gabelli Dividend & Income Trust (NYSE: GDV). The fund “invests at least 80% of its assets in dividend paying or other income producing securities. In addition, under normal market conditions, at least 50% of the Fund’s assets will consist of dividend paying equity securities.” according to its website. Currently it trades for about a 15.5% discount to its NAV. Returns have been satisfactory and the dividend yield is 6.6%, so while you wait for reversion to mean, which is about 18%, you own a fund with satisfactory performance and a good yield.

Activism

A method rising in popularity among hedge fund managers is activism. In this method the manager buys >5% of a company he believes is not returning value to shareholders and becomes active in the business until value is returned to shareholders. When selecting companies to buy the manager usually looks for undervalued companies based low cash flow multiples, or companies with a lot of FCF and cash, he then buys 5 or more percent of the company which requires him to file with the SEC, when he files he not only discloses his holdings in the company but he also writes a letter to the board of directors about why he has bought the shares, what he thinks is wrong with the company and how he believes value can be released. This filing is available for everyone to see on the SEC website.