Closed–End Fund Performance

Does Sentiment Predict UK Closed-End Country Fund Pricing?

Risk and return in trading closed-end country funds: Can trading beat holding foreign stocks?

This paper tests the impact of international investment restrictions on closed-end country funds in four Asian countries - Hong Kong, Korea, Singapore and Taiwan. The results show that the relationship between the premiums or discounts on closed-end country funds and announcements of changes in investment restrictions is sensitive to how individual countries respond to foreign innovations. A strong relationship exists in countries with large restrictions on investment - Korea and Taiwan. However, the relationship seems to break down in countries where there are virtually no restrictions on investment - Hong Kong and Singapore.

Earnings Opacity and Closed-End Country Fund Discounts

This empirical study investigates the rationale for the United States (US) closed-end equity fund discounts using investor sentiment approach of C. Lee, Shleifer, and Thaler (1991) for the period from 2004 to 2013. The result of this study suggests that discounts on closed-end equity funds decrease when small stocks return increase. The closed-end fund discounts have the significant stronger correlation with small capitalization as compared to large company’s stock returns. The results indicate that similar noise trading risk generated by retail traders explains the fluctuations in closed-end fund discounts and small capitalization equity returns even after controlling for fundamental factors. The results validated the existence of noise traders in market producing stochastic demand and supply based on their belief, subsequently affecting closed-end equity fund price in the market.

Prior Performance and Closed-End Fund Discounts

Investor Protection, Price Synchronicity and Systematic Risk: Evidence from Closed-End Country Funds

The study of international integration of equity markets has received a great deal of interest. This paper investigates whether returns of forty-one closed-end country funds share a common volatility process with three comparable return series: the underlying net asset value (NAV), U.S. stock market returns, and foreign stock market returns. Country funds are a natural setting to test for international market integration, as they are traded in the U.S. market, whereas their underlying assets are traded in foreign stock markets. Our results indicate that only a few emerging markets' country funds share common volatility processes with their comparable asset returns. This, in turn, suggests weak linkages through the second moment of related assets.

This paper investigates the impact of the onset of the COVID‐19 pandemic in the United States on closed‐end fund (CEF) discounts. I show that CEF discounts increased after the onset of the COVID‐19 pandemic in the United States, while individual investor sentiment declined. Furthermore, CEFs with higher retail ownership had a larger discount increase, which suggests that individual investor sentiment is a potential contributor to CEF discounts. This finding seems less likely to be driven by rational channels or income‐driven fire sales, as shown by further analysis. Overall, the results shed light on the CEF discount puzzle using a new setting.

In open‐end mutual funds (unit trusts), there is a strong positive cross‐sectional relationship between net inflows to individual funds and past performance, as if investors attributed performance to managerial skill. Performance shows only very weak persistence, however, so at first sight investors do not appear to gain anything by responding to past performance information. This behaviour can be explained by the fact that past performance is effectively unpriced in the unit trust market, since management fees are unresponsive to demand. If investors believe that there is a non‐zero probability that future performance will turn out to be positively correlated with past performance (i.e. that there is an element of managerial skill in performance), but a zero probability that this correlation will be negative, it is rational to prefer funds with better past performance when performance is not priced. In other words, it costs nothing to insure against the possibility of some managerial skill effect.If this explanation of the flow–performance relationship in unit trusts is correct, one would expect the relationship between investor demand and past fund performance to be much weaker if past performance were to be priced. We test this hypothesis in the market for closed‐end funds (investment trusts). Because closed‐end funds do not trade at net asset value, but at a price determined in the market, strong demand will raise the ratio of price to net asset value (known as the premium). Since it is well established that premiums are mean‐reverting, future shareholder returns on funds currently on high premiums tend to be depressed by the reversion of the premium to the mean. In the closed‐end fund market, as for open‐end funds, there is little evidence of performance persistence, and therefore, to the extent that funds with good past performance are pushed to higher premiums, the expected return on them is less than on the average fund. This implicit pricing mechanism should mean that demand is a declining function of the premium, so that, even if demand is an increasing function of past performance for a given premium, any effect on the premium itself will be muted.We test this hypothesis for closed‐end funds traded in the US and the UK. We find that there is a statistically significant effect of past performance on the premium in both countries. However, consistent with the hypothesis, it has limited economic significance, since it represents only a small component of premium variability. Copyright © 2008 John Wiley & Sons, Ltd.

This paper investigates the short-run relationship between closed-end fund prices and their net asset values. In particular, we document three systematic differences between the short-run pricing behaviors for stock and bonds funds. For equity funds, we show that returns processes for both prices and asset values have characteristics of a random walk, while bond funds returns are more predictable. Similarly, multivariate GARCH analysis establishes the existence of stronger news and volatility spillover effects between the fund price and the net asset value for bond funds than for stock funds. Finally, we find significantly weaker dynamic conditional correlations between the fund price and its fundamental value for bond funds after the Lehman Brothers failure, whereas no such evidence is found for stock funds. To explain these findings, we propose a mechanism based on bond market illiquidity.

This paper argues that recent movements in closed-end emerging markets funds present a strong challenge to the leading explanations of the behavior of closed-end country fund prices. In particular, closed-end funds dedicated to Mexico and other Latin American stock markets developed large premia after the December 1994 devaluation of the Mexican peso and the subsequent financial crisis. The so-called “investor sentiment hypothesis” could explain these events only by suggesting that investors became very optimistic about emerging markets stocks, and especially Mexican stocks; this possibility seems unlikely given the facts surrounding the devaluation. We argue instead that a sensible explanation for recent dynamics of closed-end country funds is that investors in these funds are loss-averse, implying that they do not want to realize paper losses on their closed-end fund shares. This works to put a drag on the downward movement in closed-end fund prices.

CLOSED-END investment companies for the most part normally sell at a discount from asset value. These discounts vary and in some time periods are quite substantial. Such a discount pattern contrasts with mutual funds which sell at asset value plus a sales commission, ranging in many cases from 6% to 8%C/c. This article contends that where a closed-end investment company has a satisfactory performance record there is no mathematical or logical rationale for such a discount characteristic. The discounts are primarily the result of a lack of sales effort and public understanding. A CCORDING TO DEFINITION, a myth is a story attempting to account for something in nature. By myth man tries to rationalize an occurrence he cannot otherwise understand. He may do so in various ways, but normally all myths begin with a premise somehow based on fact. This premise is then woven into an invented fabric so the whole appears about as real as would normally be desired. The investment field has fostered many myths, some of which have been long-lived and even appear immortal. On this occasion I should like to prove false several of the myths attempting to rationalize discounts applied to Regulated Closed-End Investment Companies. Such discounts do not apply to mutual funds. More specifically, I refer to the discount from asset value at which most regulated closed-end investment companies normally sell. This is illustrated in the accompanying tabulation. The discount phenomenon stretches back many years in time and may well be the aftermath of deflated illusion following the Great Crash. Prior to that time, the argument was often made that in many instances, superior closed-end investment company performance warranted premiums of 50% or more. In any case, the discounts of recent years have persisted for such a time that numerous rationalizations have developed to support their existence. Some argue the side of the built-in capital gains tax payable. Some feel the discount results from the cost (applied against income) of running an investment company. Others point to the lackluster performance of certain funds in various time periods. Some feel a basic unawareness by investors of closed-end funds is the reason. Let me dispatch these one by one. Built-in-Capital Gains Liability-Myth The first rationale, the matter of unrealized capital gains, has several things to recommend it, not the least of which is general acceptance by the investment community. It also sounds vaguely analytical, which may account for some of its appeal. But beyond this, it has little to offer for a very simple reason. It is wrong. To begin with, I am sure all will agree that irrespective of the amount of unrealized appreciation in an investment company there is no actual tax liability until gains are realized. This being the case, it does not make much difference whether unrealized appreciation accounts for as much as 95% or as little as 5 % of a company's net assets as long as the gains which are realized and distributed each year are of modest pro

Exchange‐traded funds (ETFs), like closed‐end funds (CEFs), are managed portfolios traded like individual stocks. We hypothesize that the introduction of an ETF in an asset class similar to an existing CEF results in a substitution effect that reduces the value of the CEF's shares relative to that of its underlying assets. Our event studies show that upon the introduction of a similar ETF, CEF discounts widen significantly and relative volume declines significantly. Single‐equation and systems estimation models show that the widening in discounts and reduction in volume are related to returns‐based measures of the substitutability of ETFs for CEFs.

Possibly the earliest discussion of investor sentiment, albeit unnamed, occurred during the run-up in U.S. stocks in the spring and summer of 1929 when closed-end funds mostly sold at substantial premiums to their net asset value (see De Long and Shliefer (1991)). These early writers were involved in brokerage or portfolio management, and they were warning investors that paying premiums of 100% or more was to pay twice or more the market value for the fund’s assets. The writers were puzzled by the demand for closed-end funds and were quick to point out the superior performance that fund managers would have to achieve in order to justify the lofty premiums.