Closed-End Funds: 2012 Review and 2013 Predictions
Several dominant trends for the closed-end fund industry in 2012 are expected to continue into 2013:
- A large number of mergers among funds managed by the same advisors in 2012 led to a dramatic contraction in the number of funds. While several mergers are still pending shareholder votes as we enter 2013, we expect the pace of this activity to slow.
- Only a few more closed-end fund IPOs occurred in 2012 than 2011; however, the amounts raised were markedly higher. We expect to continue to see only a few new issues come to market each month, giving each a better chance to raise a larger pool of money. The limited number of new funds has also allowed for better secondary market trading.
- More funds are maintaining base prospectuses which allow them to hold prompt secondary offerings when shares are trading at a premium, conduct rights offerings, or issue leveraging instruments without significant delay. This puts a damper on share prices as additional supply can keep prices from rising and sustaining large premiums.
- Dissident shareholder activity continued to be concentrated among U.S. and foreign equity funds whose discounts remained relatively wide in 2012. While the tone of dissident activity has been aggressive, fewer funds have been affected. Should discounts widen in 2013, we expect activists to refocus on the closed-end fund industry.
- Fund managements and dissidents still favor using tender offers to address persistently wide discounts, even though they tend not to have a long-lasting narrowing effect. Rather, the tender allows shareholders the opportunity to sell some or all of their holdings at close to NAV, essentially eliminating the discount on shares accepted for payment. This can give a fund invested in an out-of-favor sector time to allow market conditions to improve.
- As long-anticipated changes were made to ratings criteria in 2012, rating agencies downgraded closed-end fund leverage instruments, further contributing to the trend of funds changing and diversifying the forms of leverage used. While the overall cost of leverage has increased since 2008, greater leverage flexibility and the expanded ability of funds to manage their leverage should help them adapt to future interest rate changes.
- Dividends paid by several categories of closed-end bond funds, including municipals, have inched lower. However, investors have been largely unfazed by these cuts as the funds continue to offer superior distribution yields compared to other products. We expect this will continue over the short term, but could quickly result in a sell-off should investors anticipate a rise in interest rates or be confronted with other negative factors.
- Since summer 2011, the disparity in premium/discount levels between equity and bond funds continues to persist. U.S. and foreign equity funds remain at the widest discount levels, while in-demand bond funds spent most of 2012 trading at average premiums. Nevertheless, equity closed-end funds are beginning to attract increasingly positive press, and the ability to buy these funds at double-digit discounts could easily become the big story in early 2013.