Closed-End Funds: Top 7 Tips for Buying

Closed-End listed funds (or Listed Investment Companies as they are known in some parts of the world) exist only to invest in the shares of other listed companies. There are many of them listed on world markets and the main benefits of an investment in such a fund are generally given as:

1. Instant diversification in a single share (but not in all cases);

2. Professional management (but not in all cases);

3. Low cost structure compared to unlisted funds (but not in all cases);

4. They are closed end, i.e. they don’t accept new money like many unlisted funds, therefore they don’t need to invest new dollars into over-valued markets or worry about redemptions in bear markets (which occur in unlisted funds);

I say “not in all cases” after some of the above points because:

1. Not all funds are adequately diversified – the vast majority are, but some are not;

2. Managements of these funds that have under-performed a benchmark index over the years cannot be called “professional”;

3. Some of these funds have excessive cost structures in terms of fees charged and some have management agreements with an associated management company that are sometimes locked in for many years.

Therefore, you have to be very careful with which closed-end fund you choose to invest.

Top 7 Tips - These are the things that I would be looking at:

1. What shares does the fund hold in its portfolio? What are its largest positions and how do you feel about the outlook for those companies? Would you feel comfortable holding these shares directly yourself?

2. What are your feelings on the general level of the share market? If you feel it’s too high it wouldn’t be the right time to be buying, but if you feel it’s low it could be the right time;

3. Is the fund trading at a discount to its net tangible assets (NTA) – never buy a fund that is trading at a premium to NTA;

4. Does the fund have a long track record (15 years or more)? How has it performed? Funds that have underperformed the relevant benchmark index over time are not worth investing in – it should be obvious, but to many people it’s not;

5. How large are the fees? A fund that has operating expenses (this excludes income tax and any financing expenses) of more than say 0.5% of total assets is charging too much. There are in fact funds out there that are charging 2.0% or more;

6. Is there a long-term locked-in agreement between the fund and an associated asset management company? I would normally avoid these funds because a long-term locked-in agreement means shareholders are powerless to make changes if performance is not satisfactory;

7. Definitely avoid funds where the manager takes some pre-determined percentage of any out-performance of an index as a fee – never reward someone for just doing their job.

Be especially wary of the closed-end funds that have appeared in the last 4-5 years. Lots of them are run by inexperienced managers who charge high fees and have not proven themselves. These people tend to have had a few good years (during a bull market) and managed to develop a following (often through good marketing) which has then allowed them to raise millions through the float of a closed-end fund during boom times.

I would advise that people stick to the old fashioned blue chip investors that have been around for many years (if not decades).

I would still however advise that you look at their portfolios to see if you are comfortable with their positions and then only buy at a discount to NTA (at a time when you feel the market is generally low).