Closed-End Fund Abnormal Returns and Discount Mean-Reversion

Abstract

Swedish investment companies structured as closed-end funds (CEFs) are large relative to CEFs in the U.S. and elsewhere. Their costs are low and they trade at high and mean-revering discounts. I show that CEF returns are usually in excess of what can be explained by conventional risk factors. I decompose returns into return on CEF assets, return due to leverage, return due to changes in discount and other (abnormal) return. The latter is significantly positive for a portfolio of CEFs. This is exploited in a trading strategy which delivers abnormal returns of more than 10% annually. The CEFs are in essence conglomerates with listed holdings. This makes it possible to disentangle different reasons for the conglomerate discount. Discounts cannot be (fully) explained by inefficiencies, costs and potential agent problems. This suggests that investors do demand a discount for investing in a portfolio they cannot chose themselves.