Staying open to closed-end funds


By Mike Taggart, Closed-End Fund Strategist, Morningstar


The Differentiator The fundamental differentiator for closed- end funds is that they are closed. This is very simple but has serious and important ramifications. Any asset class that can be better managed with a stable pool of capital is likely to benefit investors in a closed-end funds package. The use of leverage can sometimes obscure the benefit, as leverage induces volatility, and it really comes down to managerial proficiency at investing. All else equal, though, closed-end funds offer investors many benefits just because they are closed. What do I mean by closed? With few


exceptions, once capital is raised to launch a closed-end fund, that capital is captured. After that, it is up to fund directors and executives to decide whether and when to raise more capital or to use the capital to repurchase shares. There is no creation/ redemption feature as there is with exchange-traded funds. There are no daily fund inflows/outflows to be managed as there are with traditional open-end mutual funds. Managers of closed-end funds can focus on


their core competency of making investment decisions, rather than having to worry about putting new money to work or about selling shares to meet redemption demands. This closed nature of closed-end funds


This material contains the opinions of the featured investment professional, but not necessarily those of Aberdeen Asset Management Inc., and such opinions are subject to change without notice.


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offers many benefits to investors, perhaps chief of which is that closed-end funds have an ability to invest in relatively illiquid securities. Because the capital in a closed-end fund is captured, there is no need to worry about investor redemptions or a sudden influx of capital disrupting an illiquid market.


Imagine yourself with a bit of a nest


egg and the opportunity to invest in some timberland: would you make the investment if you knew that you might need that money in the next few months to meet a financial obligation? Of course not. That investment in timberland would likely prove difficult to sell, or to monetize, in a short period. When investing in assets that are not readily monetized, the only sane investment method is to lock up the capital for long periods so that investors can't disrupt the value of the investment through their short-term actions. In this way, closed-end funds are a bit like hedge funds, with their ubiquitous lock-up periods.


Investing overseas in a closed-end fund Lately, more and more investors are expressing an interest in overseas investments. Given the state of our country's fiscal problems, many people are forecasting that the U.S. dollar is set to weaken. Executing on this thesis, they are choosing to allocate more capital abroad. And with Europe also in a fiscal mess, attention is increasingly turning to emerging markets. In my opinion, the investment vehicle of choice for U.S. emerging markets investors is the closed-end fund. Consider that investing in emerging


markets, or the markets of a developing or relatively small economy, is going to entail volatility. This volatility is apparent in the yearly returns for such markets: rarely are they single-digit gains or losses; typically they are up 70% one year, down 50% two years later, or some such. It's never boring.


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