blog

Understanding the Chords to the Closed-End Blues

By Mike T.

Closed-end funds have fallen out of favor after several years of strong asset growth. It's not that assets are shrinking, but more that growth rates have begun to show signs of fatigue. kasina had been keeping a close eye on this phenomenon as we work regularly with several managers of closed-end funds. For those of you who do not work directly with these vehicles, here is some high level commentary to bring you up to speed:

With closed-end bond funds subject to both the market implications of the credit crunch and investor confidence surrounding the crunch, any demand for CEFs in today's market would likely come via equity offerings.

The number of equity closed-end funds has risen sharply since 2001, but still only rings in at 221 (compared to 435 for closed-end bond funds). This rise has correlated strongly with the path of the DJIA, which is currently showing high volatility and downward movement since July. The perception that CEFs are less liquid and more volatile than open-ended vehicles may also contribute to investor hesitation. Deep discounts to NAV will most likely be interpreted by managers as a sign that investors are bearish on CEFs, if not on the entire market.

Lastly, closed-end funds typically rely on leveraging to drive returns. A direct implication of the credit crunch is that leveraging costs have risen significantly. With a leveraged portfolio, swings in interest rates can have huge consequences for performance. Today's interest rate climate is uncertain at best.

The next few months will be telling. As managers watch the markets and the Fed closely, the following question will be on their minds: Is this a hiccup in the strong growth of closed-end funds, or a longer-lasting downward adjustment in their popularity?