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Letter from the ICI Research: Chapter 1: Chapter 2: Chapter 3: Chapter 5: Chapter 6: Chapter 7: |
What Is a Closed-End Fund?A closed-end fund is a type of investment company whose shares are listed on a stock exchange or traded in the over-the-counter market. The assets of a closed-end fund are professionally managed in accordance with the fund’s investment objectives and policies, and may be invested in stocks, bonds, and other securities. The market price of closed-end fund shares fluctuates like that of other publicly traded securities and is determined by supply and demand in the marketplace. Closed-end funds offer a fixed number of shares to investors during an initial public offering. Closed-end funds also may make subsequent public offerings of shares in order to raise additional capital. Once issued, the shares of a closed-end fund are not typically purchased or redeemed directly by the fund. Rather, they are bought and sold by investors in the open market. Because a closed-end fund does not need to maintain cash reserves or sell securities to meet redemptions, the fund has the flexibility to invest in less liquid portfolio securities. For example, a closed-end fund may invest in securities of very small companies, municipal bonds that are not widely traded, or securities traded in countries that do not have fully developed securities markets. Closed-end funds also have flexibility to borrow against their assets, allowing them to use leverage as part of their investment strategy. Total Net Assets of Closed-End FundsTotal net assets of closed-end funds increased to $241 billion at year-end 2010, up 7 percent from year-end 2009 but still below the recent high of $313 billion in assets at year-end 2007 (Figure 4.1). Closed-end fund assets have increased by $98 billion, on net, over the past decade. Closed-End Fund Total Net Assets Increased to $241 Billion Billions of dollars, year-end, 2000–2010
Download an Excel file of this data. Note: Components may not add to the total because of rounding.
Historically, bond funds have accounted for a large share of assets in closed-end funds. In 2000, 74 percent of all closed-end fund assets were held in bond funds, while the remainder was held in equity funds. At year-end 2010, assets in bond closed-end funds were $140 billion, or 58 percent of closed-end fund assets (Figure 4.2). Equity closed-end funds totaled $101 billion, or 42 percent of closed-end fund assets. These relative shares have shifted over time, in part because issuance by equity closed-end funds exceeded that of bond closed-end funds for every year from 2004 through 2008 (Figure 4.3). Bond Funds Were the Largest Segment of the Closed-End Fund Market Percentage of closed-end fund total net assets, year-end 2010
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Proceeds from issuance of closed-end funds totaled $8.3 billion in 2010, up from $3.9 billion in the previous year (Figure 4.3). In 2010, issuance of closed-end bond funds totaled $4.6 billion, of which $4.3 billion—or about half of total issuance—was domestic bond funds. The remaining $3.6 billion in proceeds was from issuance of closed-end equity funds. Virtually all equity closed-end fund issuance in 2010 was from domestic equity closed-end funds, in contrast to 2009 in which equity fund proceeds were primarily global and international equity closed-end funds. For more data on closed-end funds, see section 2 in the data tables. Closed-End Fund Share Issuance Proceeds from the issuance of initial and additional public offerings of closed-end fund shares, millions of dollars, 2002–2010*
Download an Excel file of this data. *Data are not available for years prior to 2002. Number of Closed-End FundsThe number of closed-end funds available to investors has increased over the past decade. At the end of 2010, there were 624 closed-end funds, up from 482 at the end of 2000, but still down from 664 at the end of 2007 (Figure 4.4). Bond funds were the most common type of closed-end fund, accounting for 67 percent of the total number of funds. Municipal bond funds represented 41 percent of all closed-end funds in 2010. Equity funds made up 33 percent of the total number of closed-end funds. Number of Closed-End Funds Year-end, 2000–2010
Download an Excel file of this data. Closed-End Fund Preferred SharesClosed-end funds are permitted to issue one class of preferred shares in addition to common shares. Preferred shares differ from common shares in that preferred shareholders are paid dividends but do not share in the gains and losses of the fund. Issuing preferred shares allows a closed-end fund to raise additional capital, which it can use to purchase more securities for its portfolio. This strategy, known as leveraging, is intended to allow the fund to produce higher returns for its common shareholders. At year-end 2010, 13 percent of the $241 billion in closed-end fund assets were preferred shares (Figure 4.5). Bond closed-end funds accounted for more than three-quarters of outstanding preferred share assets. Bulk of Closed-End Fund Total Net Assets Was in Common Share Classes Billions of dollars, year-end, 2000–2010
Download an Excel file of this data. 1All closed-end funds issue common stock, which is also known as common shares. Closed-End Fund Auction Market Preferred StockIn the early 1990s, closed-end funds began issuing a type of preferred share referred to as auction market preferred stock (AMPS). AMPS are structured to pay dividends at rates set through auctions run by an independent auction agent. Typically, shares traded hands and dividend rates were reset through auctions that were held every seven or 28 days. Investors submitted bids and sell orders through a broker-dealer, who, in turn, submitted them to an auction agent. Bids were filled to the extent shares were available, and sell orders were filled to the extent there were bids. All filled bids received dividends at the new set dividend, or market clearing, rate. Since mid-February 2008, all auctions for closed-end fund AMPS have failed. The failed auctions have not been caused by defaults under the terms of the AMPS or credit quality concerns with fund investments; they failed because there were more shares offered for sale in the auction than there were bids to buy shares. Prior to the failures, if more shares were tendered for sale than purchased, broker-dealers typically would enter the auction and purchase any excess shares to prevent the auction from failing. However, broker-dealers are not, and never have been, legally required to bid for their own accounts in an auction. As a result of a series of pressures on their balance sheets, broker-dealers stopped participating in the auctions. After a few auctions failed, all subsequent auctions for closed-end fund preferred stock failed. Preferred shareholders appeared to become concerned about the liquidity of their AMPS, and many sought to sell their shares. This move by preferred shareholders increased the imbalance between supply and demand, making it difficult for the auction market to resume functioning. Redemption and Replacement of AMPSAs of year-end 2010, closed-end funds had redeemed, or announced plans to redeem, approximately $43 billion, or 67 percent, of the $64 billion in AMPS that were outstanding in mid-February 2008 (Figure 4.6). Closed-end funds have, among other things, obtained bank loans and lines of credit, issued tender option bonds, engaged in reverse repurchase agreements, and issued extendable notes to replace AMPS while maintaining leverage. Taxable bond closed-end funds have redeemed or announced redemptions for 85 percent of their original outstanding AMPS. Because tax-exempt bond closed-end funds (also known as municipal bond funds) have fewer options for alternative leverage than taxable funds do, they have redeemed, or announced redemptions for, a smaller amount (47 percent of the original AMPS outstanding). A number of these funds have issued MuniFund Term Preferred (MTP) shares and have privately placed Variable Rate Demand Preferred (VRDP) shares to redeem AMPS while maintaining leverage. Closed-End Fund AMPS Redemptions Billions of dollars, year-end, 2010
Download an Excel file of this data. Source: Thomas J. Herzfeld Advisors, Inc.
MuniFund Term Preferred Shares and Puttable Preferred StockA number of municipal bond closed-end funds issued—or announced their intention to issue— MTP shares beginning in October 2009. MTP shares are exchange-listed closed-end fund preferred shares that have a fixed dividend rate set at the time of issuance. MTP shares have a mandatory redemption period (typically five years) unless they are redeemed or repurchased earlier by the fund. Unlike fixed-rate preferred stock previously issued, MTP shares were created for issuance by closed-end funds investing in municipal bonds. Further, VRDP shares—a type of puttable preferred stock—were privately placed for a few municipal bond closed-end funds beginning in August 2008. These issuances continued throughout 2010. They are similar to AMPS in that they pay dividends at variable rates, and sell orders are filled to the extent there are bids. Unlike AMPS, however, rates are set through remarketings (rather than through auctions); and if there are more sell orders than bids, a third party, commonly referred to as a liquidity provider, purchases the VRDP shares. Dividends are set weekly at a rate established by the remarketing agent subject to a maximum rate, which will increase over time in the event of an extended period of unsuccessful remarketing. Closed-end funds are required to redeem VRDP shares still owned by the liquidity provider if there are six months of continuous, unsuccessful remarketing. Characteristics of Households Owning Closed-End FundsAn estimated 2.1 million U.S. households held closed-end funds in 2010. These households tended to include affluent, experienced investors who owned a range of equity and fixed-income investments. In 2010, 95 percent of closed-end fund–owning households also owned stocks, either directly or through stock mutual funds or variable annuities (Figure 4.7). Seventy-nine percent of households that owned closed-end funds also held bonds, bond mutual funds, or fixed annuities. In addition, 52 percent of these households owned investment real estate. Because a large number of households that owned closed-end funds also owned stocks and mutual funds, the characteristics of closed-end fund–owning households were similar in many respects to those of stock- and mutual fund–owning households. For instance, households that owned closed-end funds—like stock- and mutual fund–owning households—tended to be headed by college-educated individuals and had household incomes above the national average (Figure 4.8). Closed-End Fund–Owning Households Held a Broad Range of InvestmentsPercentage of closed-end fund–owning households holding each type of investment, May 2010*
Download an Excel file of this data. *Multiple responses are included. Closed-End Fund–Owning Households Had Above-Average Household Incomes and Financial Assets May 2010
Download an Excel file of this data. 1Total reported is household income before taxes in 2009.
Nonetheless, households that owned closed-end funds exhibit certain characteristics that distinguish them from stock- and mutual fund–owning households. For example, households with closed-end funds tended to have much greater household financial assets than either stock or mutual fund investors. Closed-end fund investors were also more likely to be retired from their lifetime occupations than either stock or mutual fund investors. For More Information
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