FYI----- CLOSED-END ETFs
Know Your Funds
A Closed-End ETF (CEF) is a publicly traded investment company that invests in a variety of securities such as stocks and bonds. Capital is mainly raised through an initial public offering and the proceeds are invested according to the fund investment objectives. Like a traditional mutual fund, a Closed-End ETF has a board of directors elected by the shareholders, and the board appoints an investment advisor and a portfolio manager.
While traditional open-end mutual funds issue and redeem shares directly with investors at net asset value, a Closed-End ETF is listed on a national exchange, where its shares are purchased and sold in transactions with other investors, not with the Closed-End ETF itself. An open-end mutual fund creates new shares every time that an investor invests in the fund, and redeems the shares when an investor redeems the fund shares. Therefore, the number of shares and the total assets fluctuate in an open-end fund as a result of purchases and redemptions. On the other hand, when an investor wishes to purchase or sell shares of a Closed-End ETF, the investor purchases shares on an exchange such as the New York Stock Exchange (NYSE). Although the outstanding shares of a Closed-End ETF remain relatively constant, additional shares can be created through secondary offerings, rights offerings or the issuance of shares for dividend reinvestment.
Advantages
There are several characteristics of Closed-End ETFs that can help investors meet their investment goals:
> Trading Liquidity and Flexibility - A stock market listing means that Closed-End ETF shares may be bought or sold at any time during the trading day. All the strategies associated with stocks, such as market orders, limit orders, stop orders, short sales, and margin buying can be used in the purchase and sale of Closed-End ETFs. Like other investments, share prices will fluctuate with the market and may be worth more or less at the time of sale than the original purchase price.
> Efficient Portfolio Management - Unlike open-end funds, which must constantly deal with cash inflows and outflows, the asset base for Closed-End ETFs is relatively stable. Without the pressure of constantly investing or redeeming securities based on investor demands, Closed-End ETFs can take better advantage of longer-term and less liquid securities or markets.
> Market Pricing - Investors who wish to buy or sell fund shares do not purchase or redeem directly from the fund - rather, they buy or sell fund shares on the stock exchange in a process identical to the purchase or sale of any other listed stock. All the strategies associated with stocks, such as market orders, limit orders, stop orders, short sales, and margin buying can be used in the purchase and sale of Closed-End ETFs.
> Leverage - Several closed-end borrow capital or issue preferred shares in order to leverage their portfolio. As long as the short-term interest rates paid to the preferred shareholders are lower than the net long-term rates earned by the underlying fund's portfolio, the common shareholders of the fund will earn higher rates that they would have without a preferred share class. If the short-term rates paid to the preferred shareholders approach the return earned by the funds portfolio, the beneficial affects of leverage will be reduced and the amount available to common shareholders will decline. At the same time, the net asset value per common share will be more volatile than those of comparable unleveraged funds since the increases or decreases in the total portfolio value are all attributed to the common shares.
> Expenses - Due to the minimal marketing expenses (recall that Closed-End ETFs have fixed shares and assets, so there is minimal need for marketing and distribution costs) and typically lower turnover, Closed-End ETFs tend to have lower operating costs than mutual funds. However, investors must still pay a brokerage commission to purchase and sell shares for all Closed-End ETFs. For those investors who trade frequently, this can significantly increase the cost of investing in Closed-End ETFs. So while Closed-End ETFs may have lower expense internally, the total costs to the investor may not be lower.
> Trading Fees - Because Closed-End ETFs are purchased and sold just like regular stocks, only brokerage fees are paid to purchase or sell shares. Closed-End ETFs typically do not impose annual 12b-1 fees, as many mutual funds do.
> Minimums - Because Closed-End ETFs trade on secondary markets like other stock, there is no minimum purchase or sale requirement. Investors may purchase or sell as little as one share of a Closed-End ETF.
> Distributions - Closed-End ETFs make distributions according to a prescribed schedule, which allows investors to plan the timing of this income. Of course, the actual amount of the distributions may vary with fund performance and market conditions.
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Investment Risk
All investments involve risk. Like other investments, Closed-End ETFs carry a certain level of risk for investors, as follows:
> Pricing Risk - The market price for a Closed-End ETF is based on the forces of supply and demand. To this extent, many Closed-End ETFs trade at a discount or premium to their underlying net asset value. Therefore, this tracking error between the market price can increase or decrease independent of the net asset value of the fund, adversely affecting an investor's portfolio value.
> Market Risk - Market prices for securities and Closed-End ETFs fluctuate daily based on a variety of factors such as economic conditions and global events, investor sentiment and security-specific factors. The degree of volatility in general in the markets has increased over the last several years. The prospect of a market decline and its impact on security and fund prices should be considered as general market risk.
> Credit Risk - Credit risk refers to an issuer 's ability to make payments of principal and interest when due. For fixed-income Closed-End ETFs, an interruption in the timely payment of principal and interest (such as on a corporate bond) may adversely affect a fund 's net asset value, price and ability to pay dividends.
> Interest Rate Risk - Prices of bonds tend to fall as interest rates rise, and rise as interest rates fall (bonds with longer maturities tend to fluctuate more in price in response to such changes). For Closed-End ETFs that hold bonds in their portfolios, this risk can be significant, although most funds hedge this risk through various market instruments.
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Buying and Selling
An investor can purchase or sell shares of a Closed-End ETF on a national exchange such as the New York Stock Exchange (NYSE) or the American Stock Exchange (AMEX) like any other stock. All the strategies associated with stocks, such as market orders, limit orders, stop orders, short sales, and margin buying can be used in the purchase and sale of Closed-End ETFs. Although Closed-End ETFs do not have the traditional 12b-1 fees charged by mutual funds, investors still pay the typical brokerage charge for the purchase and sale of shares, much like they would do with any other stock purchase and sale.
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Dividends and Distributions
Similar to traditional open-end mutual funds, Closed-End ETFs distribute their earnings to shareholders in two ways. First, income dividends from interest or stock dividends are passed through to shareholders, net of expenses. Fixed income funds typically pay out income dividends monthly or quarterly, while equity funds typically pay less frequently, often once a year. When Closed-End ETF shares are held in taxable accounts (and the fund investments are not exempt from taxes, such as for municipal bonds), these income dividends are typically taxable to the shareholder as ordinary income.
Second, realized capital gains (net of realized capital losses) distributions are passed through to shareholders. Most Closed-End ETFs make these distributions once a year in November or December.
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Net Asset Value
The net asset value, which is the value of all the fund assets minus the value of the liabilities, all divided by the number of shares outstanding, determines the value at which open-end funds (such as mutual funds) are purchased and sold. However, Closed-End ETFs are purchased and sold at market prices, which are determined by supply and demand forces on national exchanges.
When demand for fund shares exceeds supply, the market price at which a Closed-End ETF trades may be higher than its underlying net-asset-value. When there are more fund sellers than buyers, the market price may be lower than its net-asset-value. For example, if the net asset value of a fund is $20, and the fund is selling for $18 on an exchange, the fund is said to be at a 10% discount to net asset value. If the same fund is selling for $22 on an exchange, the fund is said to be at a 10% premium to net asset value.
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Performance
Shares of a Closed-End ETF are listed on a national exchange. The market price of the shares is published daily in the financial listings of most newspapers. Since the market value of shares is determined by factors including relative supply and demand of shares on the market, general market and economic conditions, and other factors beyond our control, there is no way to predict whether shares will trade at, above or below their net asset value.
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Discount/Premium
Many closed-end actually trade at discounts to their net-asset-value for a variety of fundamental and subjective reasons. However, this discount may create an attractive purchase opportunity for investors, as they are purchasing a dollar's worth of assets for less than a dollar. Fundamentally, the perceived value of a fund's shares may be less than the reported value of the fund's underlying assets. In addition, poor performance, illiquid securities, poor name recognition, and large unrealized gains may prompt a fund to trade at a discount. There are several mechanisms that the board of directors uses to minimize this price to net asset value gap. The fund can repurchase its own shares (much like a share buyback) and try to narrow the gap. The fund can open-end, which will subject the fund to the normal share purchase/redemption cash flows of mutual funds. This is difficult to do, and often requires majority approval by the shareholders.
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Portfolio Trading
The basic idea of trading an entire portfolio in a single transaction originated in the late 1970s and early 1980s. Portfolio trading was the then-revolutionary ability to trade an entire portfolio, often consisting of all S&P 500 stocks, with a single order placed with a major brokerage firm. Some modest advances in electronic order entry technology at the NYSE and the Amex, as well as the availability of large order desks at some major investment banking firms, made these early portfolio or program trades possible. At about the same time, the introduction of S&P 500 index futures contracts at the Chicago Mercantile Exchange provided an arbitrage link between the futures contracts and the traded portfolios of stocks. It even became possible, in a trade called an exchange of futures, for physicals (EFP) to exchange a stock portfolio position, long or short, for a stock index futures position, long or short. The effect of these developments was to make portfolio trading either in cash or futures markets an attractive activity for many trading desks and institutional investors.
As a logical consequence of these developments affecting large investors, there arose interest for a readily tradable portfolio or basket product for smaller institutions and the individual investor. Futures contracts were relatively large in notional size and the variation margin requirements for carrying a futures contract were cumbersome and relatively expensive for a small investor. Perhaps even more important, there are approximately ten times as many securities salespeople as futures salespeople.
AI
