Because they don’t have to worry about redemptions, closed-end funds can be completely invested and usually do not have a cash drag.
If investors decide to flee a closed-end fund en masse, its price will likely fall, but its net asset value won’t necessarily be affected at all—the result is likely to be a widening discount.
After a closed-end fund is initially offered, it closes and shareholders can then trade only a fixed number of outstanding shares—thus, the assets are relatively stable. This allows their managers to access less-traded areas of the market to find larger dividends for investors.
“If you’re subject to redemptions, you have to sell securities which may be sensitive to a declining interest rate environment,” says Alan Goodson at Aberdeen Standard Investments, who oversees products for the Americas. “Depending on the direction of yields, you may be forced to sell bonds with a higher coupon than you can find in the market at that given time. In closed-end funds, you’re not subject to redemptions.”
Aberdeen offers a lineup of more than a dozen closed-end funds, says Goodson. Mostly they are income-oriented, many focusing on international investments. The largest of these, the $1.8 billion Aberdeen Asia-Pacific Income Fund (FAX) seeks current income by investing in Australian, New Zealand and Asian debt securities. As of May 2, FAX traded for $4.10, a 14.4% discount to its net asset value of $4.79.
The fund carries a 2.26% expense ratio. Over the past decade, it has offered an average annualized return of 6.4% on a market price basis. “It’s a portfolio that has much of its assets in bonds that are rated investment grade or higher, and it pays out a yield that is just shy of 7%,” says Goodson. “You can compare that to the Barclays high-yield aggregate bond index, which has an average credit rating of C and a yield of just over 6%.”
Because they do not have to worry about share creation or redemption, closed-end fund managers have more flexibility to try to pay a consistent yield to their shareholders. A closed-end fund’s limited number of shares also constrains its usefulness for investors and advisors seeking to put large amounts of money to work. While there are many closed-end funds with more than $1 billion in assets, it’s a relatively small space that does not trade very often.
When Carroll’s firm grew and he looked to make larger trades on behalf of his clients, he found that he could no longer find the liquidity or supply he needed in the closed-end fund space. “We don’t do much work in closed-end funds, though we have in the past, because the firm has gotten pretty big,” says Carroll. “We’re managing $3 billion, and there’s not enough liquidity in closed-end funds. For most closed-end funds, if I bought $10 million worth of shares, I’m going to move the price. For a lot of them, if I bought just $1 million in shares, I’m going to move the price. When you get larger amounts of money under management, it’s difficult to do much in closed-end funds.”