Dear Mr. Berko: In May 2013, I bought 1,000 shares of First Trust Intermediate Duration Preferred & Income Fund at $25, which were supposed to pay me 15.2 cents a month, or a 7.3 percent annual yield. The symbol is FPF, and it now trades at $22, which means I’m down $3,000, and at the current rate, it will take me at least two years to make up my losses. Every time I buy a closed-end fund at the new issue price, I end up losing money because they always trade below the offering price in a couple of months. My broker assured me that FPF would not drop as others have, but nearly three months after my purchase date, the price of FPF had crashed to $20.30. It has recovered by $1.70 since then, but my question is this: Seeing as the yield is 8.3 percent at the current price, should I buy another 1,000 shares?
— RP, Durham, N.C.
Dear RP: Initial public offerings of closed-end funds and exchange-traded funds are for suckers and are one of the biggest swindles on Wall Street. Never, never, a thousand times never, buy a CEF or an ETF as a new issue from a brokster. A caring broker would tell you that the best time to purchase a CEF or an ETF is about three months after the offering, when the price is likely to be between 10 and 20 percent below the IPO price.
The net asset value of a CEF or an ETF or an open-end fund is synonymous to its book value. This number is calculated by adding up the market value of all the stocks in a fund’s portfolio, subtracting its liabilities and dividing the resulting figure by the number of shares outstanding. This is the dollar amount all shareholders receive when any company liquidates itself.
When a CEF or an ETF comes public via an IPO, its shares are sold at net asset value plus a 6 percent commission. So when FPF came public at $25, its NAV was $23.58, and the commission was $1.42. And because the NAV was worth only $23.58 on the IPO date, the selling brokers supported the IPO price of $25 for three months so thousands of clients wouldn’t feel they were being ripped off at $25. But when the selling brokers drop their support, those shares usually drop like coconuts from tall palm trees. From personal observation, I’ve found there’s a 97.6 percent degree of probability that an IPO of an ETF or a CEF will, within 90 days, drop in price by the amount of the commission (6 percent) and trade at NAV. And then there’s a 93.2 percent degree of probability (in that same time frame) that the price will drop further — somewhere between 3 and 10 percent below the fund’s NAV.
