Analyst’s report
“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.”
Imagine managing a securities portfolio tied to such a highly volatile local market in a traditional open-end mutual fund. In years of strong performance, U.S. investors pile into the fund, forcing investment managers to put new money from inflows to work in an already frothy environment. Even if you hold some of it in cash rather than invest near what you know is a short-term market top, you are unlikely to beat the country's index benchmark. Eventually, as always happens, short-term investors leave a fund for the next big investment idea (social networking firms, for instance)—often at a time when the market is declining. In those cases, portfolio managers are forced to sell relatively undervalued shares in a declining market in order to meet redemption requests. This scenario sounds simplistic, but it recurs every market cycle with open- end mutual funds. Now, consider the same portfolio
manager managing a closed-end fund. The portfolio can be constructed around the best companies in the local markets. The waxing and waning of investor interest in the local market affects the share prices of the closed-end fund, not the capital that you are investing. Instead of worrying about cash inflows/outflows, closed-end fund portfolio managers can remain focused on the fundamentals of the local market. At times of severe market sell-offs,
a closed-end fund might even attempt to raise more capital so that a fund manager, at their discretion, can have fresh capital near the bottom of a cycle to invest in good companies at bargain prices. Open-end funds have their role in
investors' portfolios, obviously. Large fund families, in particular, tend to have the infrastructure in place to help their portfolio managers manage the daily inflows and outflows of cash in good times and bad. Fund families that have both open-end funds and closed-end funds under their purview also tend to have their managers overseeing capital in both types of vehicles, so shareholders are treated to similar portfolios of diversified holdings.
Active management Emerging markets investing, in particular, calls for active management, in my opinion. And before investors decide whether to opt for the open-end fund or closed-end fund, it is also important to consider fund fees, the management company's resources and reputation, the manager's performance track record (though past performance is no guarantee of future performance). For closed-end funds, the discount/ premium and the reasons for it need to be considered.
Conclusion
When I come across an open-end fund and a closed-end funds offering the
same exposure to an asset class, if all
else is equal, I choose the closed-end funds. Not because I'm a closed-end fund analyst, but because of the closed nature of the capital flows. It’s the ability of a closed-end funds
portfolio manager to focus on the underlying markets – rather than fund inflows/outflows – that I believe sets the closed-end funds apart from other investment vehicles.
Mr. Taggart, CFA, leads Morningstar’s closed-end fund research team, which also includes Cara Scatizzi. Backed by Morningstar’s comprehensive data team, the team covers more than 100 closed- end funds, while keeping their eyes on the entire universe. In addition to researching individual funds, they also write about broader issues that can affect investors and manage a comprehensive closed-end fund solutions center. Mr. Taggart has more than 15 years of financial industry experience and is a chartered financial analyst.
www.morningstar.com/Cover/CEF- Closed-End-Funds.aspx
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