Scott Burns writing for the Houston Chronicle makes a past performance case for closed-ends funds, mutual funds that issue a set amount of shares, which trade on an exchange like shares of a stock:
Here's an interesting factoid. Over the three years ending May 30, the average mutual fund that invested in domestic equities has provided an annual return of 13.30 percent.
Rather nice.
Until you compare it with another return. The average closed-end fund, mutual funds that has returned 17.03 percent annually over the same period."
Now before you run out and buy a closed-end fund, let’s think about a few issues specific to closed-end funds that may have played a role in this recent streak of outperformance:
1) Leverage. Most closed-end funds leverage their portfolios with borrowed money. And why not? They get paid a management fee based on total assets, including borrowed money. That can prove to be one heck of an incentive to borrow. How has this juiced returns? Through much of the last three years borrowing was very cheap. More important, stock markets have been very hot. A fund manager throwing darts at the stock page and investing in the ones he hits in a leveraged portfolio is going to beat an unleveraged portfolio if stocks in general are going up more than the cost of borrowing.
2) Discount Erosion. Closed-end funds can trade at a premium or discount to NAV, or net asset value. This means that when closed-end funds are out of favor (say when reporters are not writing about their streaks of outperformance…) they can trade at ninety cents on the dollar. After strong runs in stocks, investors may bid up these discounts away completely.
Why is this important? Imagine two S&P 500 index funds, one a regular open-end fund, the other a closed-end fund trading at a 10% discount to NAV. If the S&P 500 index climbs 10% one year and the closed-end fund discount goes from 10% to 5%, the closed end fund will be up over 16% compared to the 10% return of the open-end index fund. Add in leverage and the gap would grow even more.
Now that closed-end discounts are much lower, interest rates are higher, and stock markets are more expensive, what are the odds that a leveraged closed-end stock fund will beat a traditional open end fund over the next three years? What if stocks get weak and the wide discounts to NAV return, and the fund managers of closed-end funds keep the leverage (and therefore management fees) up?
There are other reasons closed-end funds can be decent investments – in fact we’ve picked some in our past MAXadvisor Powerfund Portfolios HotSheets. These include smaller portfolios sizes, more experienced managers, and no hot money (in and outflows of money that hurt open-end fund returns).
You can track these important variables for open-end funds right here at MAXfunds. And remember to look forward as well as backward when picking funds.
Scott Burns writing for the Houston Chronicle makes a past performance case for closed-ends funds, mutual funds that issue a set amount of shares, which trade on an exchange like shares of a stock:
Here's an interesting factoid. Over the three years ending May 30, the average mutual fund that invested in domestic equities has provided an annual return of 13.30 percent.
Rather nice.
Until you compare it with another return. The average closed-end fund, mutual funds that has returned 17.03 percent annually over the same period."
Now before you run out and buy a closed-end fund, let’s think about a few issues specific to closed-end funds that may have played a role in this recent streak of outperformance:
1) Leverage. Most closed-end funds leverage their portfolios with borrowed money. And why not? They get paid a management fee based on total assets, including borrowed money. That can prove to be one heck of an incentive to borrow. How has this juiced returns? Through much of the last three years borrowing was very cheap. More important, stock markets have been very hot. A fund manager throwing darts at the stock page and investing in the ones he hits in a leveraged portfolio is going to beat an unleveraged portfolio if stocks in general are going up more than the cost of borrowing.
2) Discount Erosion. Closed-end funds can trade at a premium or discount to NAV, or net asset value. This means that when closed-end funds are out of favor (say when reporters are not writing about their streaks of outperformance…) they can trade at ninety cents on the dollar. After strong runs in stocks, investors may bid up these discounts away completely.
Why is this important? Imagine two S&P 500 index funds, one a regular open-end fund, the other a closed-end fund trading at a 10% discount to NAV. If the S&P 500 index climbs 10% one year and the closed-end fund discount goes from 10% to 5%, the closed end fund will be up over 16% compared to the 10% return of the open-end index fund. Add in leverage and the gap would grow even more.
Now that closed-end discounts are much lower, interest rates are higher, and stock markets are more expensive, what are the odds that a leveraged closed-end stock fund will beat a traditional open end fund over the next three years? What if stocks get weak and the wide discounts to NAV return, and the fund managers of closed-end funds keep the leverage (and therefore management fees) up?
There are other reasons closed-end funds can be decent investments – in fact we’ve picked some in our past MAXadvisor Powerfund Portfolios HotSheets. These include smaller portfolios sizes, more experienced managers, and no hot money (in and outflows of money that hurt open-end fund returns).
You can track these important variables for open-end funds right here at MAXfunds. And remember to look forward as well as backward when picking funds.
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