Looking Out For Investment Trouble Spots

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No one can honestly predict the performance of the stock market. Even seasoned investors will say that part of the game is making risky calls and seeing how they pan out.

A fundamental problem of investment policy is illustrated by a question that owners of investment company stocks often ask: "From your comment about economic conditions and the outlook, you obviously believe stock prices are high. Why don't you sell stocks with the idea of repurchasing at lower prices? After all, the difference between the sales prices and the cost of repurchase may equal dividend payment not for one but for a number of years."

The answer is that dividend income of carefully chosen stocks has a considerable degree of certainty, whereas successful catching of a turn in the market involves a large degree of uncertainty. First, stock prices may not fall, the decline may occur only after a long time. Secondly, there is no assurance that once a decline has set in, purchases will not be delayed to await a further decline, and repurchase will be delayed until prices are again as high or higher than when sales were consummated.

The investor also should be aware of a problem confronting open-end investment company managements. This problem affects both current stockholders and new purchasers of open-end company shares. There has been a fairly well defined tendency for sales of open-end-company shares to be higher in strong, active markets than in periods of dull, declining markets. This means that the flow of funds into open-end companies for investment is larger when prices are relatively high and when the indicated dividend return is relatively low, or at least lower than during periods when funds received from the sale of additional shares are not as large (as in 1945, 1946, 1956, 1957, or 1958, to cite a few instances). The result is a kind of dilution, insofar as the "old" holder is concerned. Income per dollar of investment is likely to be reduced, and the average cost of the shares held in the portfolio may be raised.

Solving this problem is difficult. Management may counteract incipient dilution by buying short-term Treasury or corporate obligations. This may involve the loss of income. In a sense, it also expresses doubt about the near-term course of stock prices. If so much doubt exists, is it fair to invite investment in the shares of the open-end fund? It must be conceded that the problem is difficult to appraise. Evidence does not establish a clear-cut superiority in the results of closed-end over open-end companies, and the former operate without having to meet this problem. Only education in restraint on the part of investors can eliminate this variety of dilution. Perhaps, as the number of investors who buy shares in open-end investment companies continues to increase, so that the flow of funds is maintained at a steadier pace, regardless of the level of the stock market, the problem will be reduced to insignificant proportions.

Having discussed a matter of some concern for shareholders in open-end investment companies, one may consider another "trouble spot," relating this time only to closed-end companies. A number of closed-end investment company shares sell at a discount from net asset value.

A good case can be made for a policy of repurchase of outstanding shares where the discount is sufficiently large, but management often does not wish to reduce the amount of capital that it commands. One step further: Management believes that it could employ additional funds to advantage. The reception of new stock issues by investors may have been very favorable. The directors decide to ask stockholder approval for the sale of additional shares, and as usual, the proposal is adopted.

Investors often accept management's decision to issue new stocks, and this can be to the benefit of both the company and the shareholder. Investors only need be careful that they have invested in legitimate companies that will not go belly-up unexpectedly.

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