Value Investing

Special Opportunities Fund, Inc: Market Price Best Measure Long-Term

Dear Fellow Shareholders:

Special Opportunities Fund, Inc: Market Price Best Measure Long-Term

The goal of Special Opportunities Fund is to outperform the market over the longterm with less short-term risk than a broad-based index fund. On December 31, 2013, the Fund’s market price closed at $17.45 per share after a year-end distribution of $2.21 per share, representing an increase of 16.13% in the second half of 2013 while the S&P 500 Index capped a very strong year by advancing 16.32%. For the year, the Fund’s market price was up 31.27% vs. 32.39% for the S&P 500 Index. All in all, we think we had a pretty good year. Even with the leverage from our convertible preferred stock, we incurred substantially less risk than the S&P 500 Index. Also, we have a fair amount of investments that are uncorrelated with the stock market.

In previous letters, I discussed some problems with measuring performance of a closed-end fund. I concluded that using the NAV alone was the best measure of performance because short-term movements in the discount (or premium) could distort reality if reality means assessing how the Fund’s advisor performed. For example, if a fund’s NAV was flat for the year but its discount narrowed from 15% to 10%, the market price return would be 5.88%. On the other hand, if its discount widened from 15% to 20%, the market price return would be (5.88)%. But, in either case, the manager had the same NAV performance.

However, after thinking about it some more, and given the complexities of accounting for dilution from stock dividends (with an option for cash) or rights offerings, paying taxes on retained capital gains (as happened in 2012), accretion from share repurchases, etc., I now believe that the Fund’s market price is the best measure of long term performance. While, as indicated above, changes in the discount can indeed distort a fund’s short-term performance (attributable to the advisor), such distortion tends to be relatively insignificant when long-term performance is calculated based upon market price.

In any event, certain assumptions have to be made. For example, what assumption is made when transferable rights are distributed to shareholders, as happened in 2012 when the Fund issued rights to buy shares of a newly issued convertible preferred stock? Should we assume the rights were sold and if so, when and at what price? Or should we assume the rights were fully exercised? Or should we assume a shareholder fully exercised his or her rights and oversubscribed? And, if we assume the rights were exercised, what about the performance of the newly issued securities? Or, if non-transferable rights are issued, should we assume they are exercised or left to expire unexercised? Similarly, what should we assume a shareholder does when a stock dividend is declared with an option for cash? If anyone has any thoughts about how to handle these sorts of performance-related conundrums, please let us know.

Since our last letter, the Fund has increased its exposure to income oriented securities whose market prices have fallen much more than their intrinsic value due to fear that the Fed may “take away the punch bowl.” It also continues to hold a number of investments that have little or no correlation to the stock market such as SPACs and auction rate preferred stock (both of which are very safe), and special situation stocks like Gyrodyne and Imperial Holdings. Here is the status of some of our larger positions and a few odds and ends. Please refer to our previous letters for more background.

Firsthand Technology Value Fund (SVVC)

We began purchasing shares of SVVC in 2012 after its stock fell to a discount of more than 20% below NAV as a result of Facebook’s poorly received IPO. The discount narrowed prior to Twitter’s much hyped IPO and we took the opportunity to sell more than half of our shares at a single digit discount to NAV.

See Full PDF here: Special Opportunities Fund

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