Closed-end Funds Research Articles

The Closed-End Fund Puzzle Between Classical Finance and Behavioral Finance: A Survey

This paper presents a thorough review, including the authors' latest thinking, of one of the most persistent and troubling puzzles to the efficient market hypothesis: the closed-end fund puzzle. Financial economists have intensely scrutinised the economic explanations of the discount within the context of the efficient market hypothesis. Unfortunately, empirical evidence show that none of the traditional explanations individually accounts for all aspects of the closed-end fund discount. The failure of economic hypotheses to explain the closed-end fund discount leads many authors to explore behavioral explanations. We outline then the psychological evidence for this phenomenon and give a taxonomy for an array of factors that come under the common label of sentimental hypothesis.

A Liquidity-Based Theory of Closed-End Funds

This paper develops a rational, liquidity-based model of closed-end funds (CEFs) that provides an economic motivation for the existence of this organizational form: they oer a means for investors to buy illiquid securities, without facing the potential costs associated with direct trading and without the externalities imposed by an open-end fund structure. Our theory predicts both the patterns observed in CEF IPO behavior, and the observed behavior of the CEF discount, which results from a tradeo between the liquidity benefits of investing in the CEF and the fees charged by the fund’s managers. In particular, the model predicts that IPOs will occur in waves in certain sectors at a time, that funds will be issued at a premium to net asset value (NAV), and that they will later usually trade at a discount. We also conduct an empirical investigation. Overall, we find qualitative and quantitative support for both the liquidity motive for issuing CEFs and the model’s predicted patterns in the premium/discount. In addition, we find evidence that the speed of reversion from premium to discount after a fund’s IPO is less rapid than suggested by prior research. However, we document one feature of the data that our model cannot explain: the return of newly issued funds under-performs that of seasoned CEFs. This overpricing at the IPO suggests that a full explanation of the discount may also require behavioral considerations.

The Closed-End Fund Premium Puzzle and Portfolio/Fund Risk Differences

Seemingly at odds with market efficiency, it is well-known that closed-end funds (CEF) trade at a discount (negative premium) to the net asset values (NAVs) of the portfolios these CEFs hold. Yet, since the CEF shares and the underlying securities held by the CEF trade in completely different markets (with limited means of cross-market arbitrage), the returns on the CEF and the returns on the underlying portfolio may not move in lock-step. In this paper, we investigate whether the returns of closed-end funds (CEFs) behave differently than the returns of the underlying portfolio of securities held by the CEF. We show that, on average, the returns on CEFs have significantly (both economically and statistically) higher risk (i.e., factor loadings) and volatility than the returns on their underlying portfolios (i.e., NAV returns), but have roughly the same mean returns. We also show that the difference in risk and performance between the CEF and its NAV explain cross-sectional variation in the size of difference between the NAV and the price of the CEF (i.e., the CEF premium). Possibly adding to the puzzle though, we find that idiosyncratic risk is positively related to CEF premiums (higher relative idiosyncratic risk for the CEF results in higher relative CEF price to NAV). Our conclusion is that CEFs have a life of their own and that the difference in the return behavior rationally accounts for (at least a portion) of the CEF premium puzzle.

The Secondary Market for Hedge Funds and the Closed Hedge Fund Premium

Rational theories of the closed-end fund premium puzzle highlight fund share and asset illiquidity, managerial ability and compensation, and fees as important determinants of the premium. Several of these attributes are difficult to measure for mutual funds, and easier to measure for hedge funds. This paper employs new data from a secondary market for hedge funds, discovers a closed hedge fund premium which is highly correlated over time with the closed-end mutual fund premium, and shows that the closed hedge fund premium is well-explained by variables suggested by the rational theories. Sentiment-based explanations do not find support in the data.

Capital Gains Taxes, Agency Costs, and Closed-End Fund Discounts

We test two hypotheses about the determinants of closed-end fund premia and discounts using a comprehensive sample of non-taxable and taxable funds for the period 1988 to 2002. We test whether fund premia reflect agency costs, and the potential tax liability associated with unrealized capital gains by examining changes in fund premia around the declaration day of large dividend and capital gain distributions. We provide further evidence on the effect of the tax liability from unrealized capital gains by examining changes in the premium around the ex-day of capital gain distributions. Our results lend support to both agency cost and the capital gains tax explanations for fund premia and discounts. We also find that the market prices of municipal bond funds (which pay tax-free dividends) are more sensitive to capital gains tax liabilities than are the prices of taxable funds, which is consistent with the existence of tax clienteles among closed-end fund investors.

An empirical analysis of Mexican and US closed-end mutual fund IPOs

We examine 135 Mexican closed-end fund IPOs and 370 Mexican non-fund IPOs that issued between 1994 and 2003 along with 217 contemporaneous US fund IPOs and document three primary results. First, we find that Mexican IPOs in the aggregate experience no significant underpricing, unlike their US IPO counterparts. Both Mexican and US IPOs experience significantly negative long-run performance. Second, Mexican closed-end fund IPOs experience positive long-run performance, significantly better than Mexican non-fund IPOs which experience negative long-run performance. Unlike Mexican fund IPOs, US fund IPOs experience negative long-run performance. Third, we find that both Mexican and US debt-backed closed-end fund IPOs significantly outperform equity-backed closed-end IPOs. In Mexico, debt-backed funds experience positive abnormal returns, compared to negative abnormal returns for Mexican equity-backed funds, US debt-backed funds, and US equity-backed funds.

Portfolio concentration and closed-end fund discounts: Evidence from the China market

This paper provides an analysis of the determinants of the closed-end fund discount in Mainland China. We focus on the diversification level of closed-end funds as the investor clienteles for closed-end funds in Mainland China are different from other markets. Our empirical evidence shows that discount is strongly and negatively related to stock concentration as measured by the number of stocks in the fund or Herfindahl index. We also find the discount decreases with the dividend payout and turnover, suggesting that investors are willing to pay a higher price (lower discount) for a fund that pays more dividends and has higher turnover.

Information flows during the Asian crisis: Evidence from closed-end funds

We test for the direction of information flow between US and Asian equity markets by comparing prices in Asian equity markets with prices of US-based closed-end funds that invest in those markets. Exploiting the fact that trading hours in the two regions do not overlap, we find that the day-to-day influence of local-market returns on the corresponding fund returns abroad was stronger before the crisis, while effects in the opposite direction rose somewhat during the crisis. This suggests that US market sentiment assumed a relatively more important role in driving Asian market developments during the crisis, while US investors were relatively less influenced by the views of Asian investors.

Information Flows During the Asian Crisis: Evidence from Closed-End Funds

A salient feature of the Asian crisis of 1997 was a collapse of stock markets that took place over several months. The dynamics of this collapse raises the question of what information was driving the markets. This paper examines a key aspect of this question: did information flow from the domestic Asian markets to overseas markets, or vice versa? We test for the direction of this information flow by comparing daily returns in several Southeast Asian equity markets with daily returns on US-based closed-end funds that invest in those markets, exploiting the fact that there is no overlap between the trading hours in the two regions. We find that while information flows between local and US markets tended to be roughly evenly balanced before the crisis, US market returns assumed a more important role during the crisis. This is the case both for the level of daily returns and for the volatility of those returns. We also find that fund returns were more closely tied to broad US market returns during the crisis period. This suggests that the shift in causation between the US and Asia reflected a greater role for US market sentiment, rather than for the news that became known during US trading hours.

American Capital Strategies Ltd.

AbstractFinance Intermediaries & Services (MIC: 8.7 SIC: 6726 NAIC: 525990)American Capital Strategies is a closed end investment company. Co. invests in senior debt, mezzanine debt and equity in the buyouts of private companies that it sponsors, the buyouts of private companies sponsored by other private equity firms and directly to private and small public companies. Co. also invests in structured finance investments including commercial mortgage backed securities, commercial collateralized loan obligation securities and collateralized debt obligation securities and in alternative asset funds that it manages. Co. also provides advisory, management and other services to its portfolio companies through American Capital Financial Services, Inc.

Institutional Portfolio Flows and International Investments

Using a new technique, and weekly data for 25 countries from 1994 to 1998, we analyze the relationship between institutional cross-border portfolio flows, and domestic and foreign equity returns. In emerging markets, institutional flows forecast statistically indistinguishable movements in country closed-end fund NAV returns and price returns. In contrast, closed-end fund flows forecast price returns, but not NAV returns. Furthermore, institutional flows display trend-following (trend-reversing) behavior in response to symmetric (asymmetric) movements in NAV and price returns. The results suggest that institutional cross-border flows are linked to fundamentals, while closed-end fund flows are a source of price pressure in the short run.

Market segmentation, liquidity spillover, and closed-end country fund discounts

In a segmented international capital market, the illiquidity of a country fund in the market in which its shares are traded affects only the share price of the fund ( S), while the illiquidity of its underlying assets in the market in which these are traded affects only the fund net asset value ( NAV). In an integrated market, illiquidity in one market can easily spill over to another and affect both the fund share price and its underlying asset value. It follows that the closed-end country fund premium, P≡ln( S)−ln( NAV), is negatively (positively) affected by the fund (underlying asset) illiquidity in segmented capital markets, but has only an ambiguous association with either fund or underlying asset illiquidity in an integrated market. Empirical evidence for the 8/1987 to 12/2001 period from U.S.-traded single-country closed-end funds shows that the fund premium has a negative (positive) association with the fund (underlying asset) illiquidity, and the relation is much stronger for funds investing in segmented markets. The results suggest that illiquidity plays a significant role in explaining closed-end country fund premia.

Assessing and Managing Risk in Institutional Real Estate Investing

Executive Summary.In the current environment, investors are increasingly asking: does real estate offer enough return to warrant the risk? In particular, do investors really understand the increased risk they are taking on in the trend of recent years toward ever higher risk strategies in closed-end funds? To better inform institutional investors in making this decision, this paper offers some new views. First, it classifies and evaluates risk by its impact on the various components of portfolio returns. Second, these risks are considered in the strategic contexts of core, value-added, and opportunistic investing. Examining the interplay of risks reveals a particularly high concentration of risks in the opportunity fund arena. Finally, to control risk, this paper offers some management choices available to institutional investors: time horizon, diversification methodologies, hedging approaches, and strategic choices to limit risks.

Redeemability as Governance: A Study of Closed-end and Open-end Funds under Common Management

Redeemability as Governance: A Study of Closed-end and Open-end Funds under Common Management

The Anomalous Behavior of the S&P Covered Call Closed End Fund

This paper examines the anomalous behavior of the S&P Covered Call Closed End (BEP) Fund, which traded in 2007 at substantial premiums to its NAV that reached 23 percent. The large premium is striking in light of the highly transparent and easy to replicate strategy of the fund, which involves rolling over one month, at the money S&P 500 index covered calls. The paper finds that the large premium owed to BEP returns overreacting to positive S&P returns, adjusted for the deltas and gammas of the options that the fund was short. Another possible explanation for the emergence of the large premium is the near doubling of the VIX from very low and stable levels, which may have encouraged unsophisticated investors to buy the BEP fund at increasingly elevated premiums. The paper then examines the anomaly from the perspective of the noise trader literature and finds that the volatility of BEP returns was high relative to the volatility of the underlying fundamentals and that large premiums did not emerge at other covered call closed end funds. The evidence also suggests that short covering may have been a factor behind the surge of the premium as short positions grew substantially during this period, consistent with the noise trader model of Abreu and Brunnermeier (2002) that emphasizes the timing risk associated with arbitrage.

Managerial Ability, Open-End Fund Flows, and Closed-End Fund Discounts

Managerial Ability, Open-End Fund Flows, and Closed-End Fund Discounts

Business Valuation Cases in Brief

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn MailTo Tools Icon Tools Get Permissions Cite Icon Cite Search Site Citation John J. Stockdale; Business Valuation Cases in Brief. Business Valuation Review 1 July 2008; 27 (2): 124–126. doi: https://doi.org/10.5791/0882-2875-27.2.124 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest Search

The Efficiency of International Information Flow: Evidence from the ETF and CEF Prices

While similar in their trading and organization, closed-end funds (CEFs) and exchange-traded funds (ETFs) differ in their liquidity and ease of arbitrage. We compare their price transmission dynamics using a sample of funds that invest in foreign securities and are most likely to show the deficiencies in the manner in which they process information. Our analysis shows that ETF returns are more closely related to their portfolio returns than CEF returns. However, both fund types underreact to portfolio returns but overreact to domestic stock market returns. A simple trading strategy using these results is profitable with roundtrip trading costs less than 1.38% for CEFs and 0.71% for ETFs.

Managerial Ability, Open-End Fund Flows, and Closed-End Fund Discounts

I construct a dynamic rational expectations equilibrium model to unify open-end fund flows and closed-end fund discounts based on managerial ability. The model features both endogenous portfolio management of fund managers and endogenous fund purchase decisions of fund investors. The fully calibrated model matches many quantitative features of open-end fund flows and closed-end fund discounts. Furthermore, I propose a new economic theory to explain the convex flow-performance relationship, documented by previous empirical research on open-end fund flows. The proposed theory highlights the importance of incorporating active portfolio management into economic analysis of fund flows. Within the unified framework, the model predicts a convex premium-performance relationship when applied to closed-end funds. I empirically test and confirm this novel prediction.

Information, Sophistication, and Foreign Versus Domestic Investors' Performance

Using an intraday transaction dataset with trader identity, we study foreign and domestic investors' trading activities and investment performance ahead of open-ending events of Taiwanese closed-end funds. Simply buying the funds at a discount and holding until open ending generates large abnormal returns. All information required to execute this strategy is made public, so the events set up natural experiments to examine how investors trade, holding constant access to information. Foreign investors are net buyers ahead of the open endings, more than doubling their positions and earning large abnormal returns. Domestic investors are net sellers while the discounts are still large, and forego large abnormal returns. The results suggest that investor sophistication in interpreting the same information is potentially an important determinant of investment performance differences across foreign and domestic investors.