One hot topic in the closed-end fund world the past few years has been buying funds on the IPO. This is the primary way in which a new CEF is born. About a year ago, Morningstar did a study with the premise that CEF IPO investors didn’t lose money if they held onto the fund for a long time. The article was done in two parts and you can read them here: Part One and Part Two. While I would agree that they make some good points, a few questions lingered.
- How did investors do if they had delayed their entry into the fund post IPO?
- Are there certain time periods in which the CEF structure tends to do better than a peer ETF? This is also an attempt to take the market movements out of the results and focus on the structural differences in owning a CEF vs. an ETF or open-end fund.
To begin, we selected potential entry points post-IPO. They were (in calendar days): on the IPO date, 1 week, 45 days, 90 days, 180 days, 270 days and 1 year post-IPO. The reason for these entry points was simply to provide points that we could easily remember going forward if the study proved enlightening.
To test these entry points, we examined the returns of each of the funds exactly 2 years post-IPO if the investor had entered at each of the above-mentioned dates (imagine standing two years down the line from the IPO date and looking back to each of these entry points and entering then). Next, we netted out the returns of the market to isolate the potential “alpha” that these funds provided. To do this, we matched comparable ETF’s for each type of fund and subtracted out the returns from the same dates that we were examining in the CEF. This way, we could see the actual effects and performance of the fund, and possibly the market forces on the fund on and after the IPO date.
We examined several types of CEF’s. The categories of funds we studied were: US equity, global equity, US REIT, International REIT, MLP, municipal bond, junk bond and senior loan bond. We had to find CEF sectors that had tracking ETFs available for a two year period with enough funds to make the comparison about the structure vs. the individual fund results. We used a 20 year look back because about 70% of funds were IPO’ed beginning in March 1993. In total we examined 51 funds. A full list of funds examined is available upon request.
For the given entry points post-IPO, we produced the following percent performance results for the average CEF studied.
From these results, we see that of these entry points, entering 270 calendar days post-IPO is historically the best day to enter. Before the study, we suspected it would be after the 45 day Greenshoe option and once the fund was able to trade on pure market forces. This is the share over-allotment option that allows underwriters to short sell shares at the offering price and is usually 15% of the IPO’ed number of shares.
We also thought it might be about six months, just before the fund released its first semiannual report. One of the main reasons we believed it would be between 180 and 365 days was that after the fund has one year of market data and a full annual report, we had noticed – and now proved - that the CEF typically has more buying interest post 12 months. We believe this stems from the fund having more comparable data for peer analysis and more insight into what the portfolio manager is doing with the fund’s assets. This higher amount of transparency can easily lead to higher prices vs. NAV and buying before this occurs can improve your returns as long as you are willing to take some added risk in having less transparency.
One other point of note is that we can start to see around 45 days post-IPO that fund-specific returns begin to become positive. This agrees with one of our original hypotheses that the Green Shoe props up the market price, while post Green Shoe, most funds start trading at discounts to NAV. The IPO commission to bring the stock to market is usually about 4.5% of NAV.
Examining this chart, the next logical step was to find the best day to enter post-IPO, i.e. which day post-IPO, on average, yields the best fund-specific return (we also found the worst day to invest). We did this by calculating the net return (return of the fund minus return of the comparable ETF) of the fund if the investor were to enter the fund at any of the days within the two-year window. We performed this on the same group of funds that we described above. We also calculated the actual average and median returns for the investors if they were to enter in at the best and worst days. The sector-specific results were as follows for each sub group.
As seen in the data above, the results for the actual “best” and “worst” day to purchase the fund in the various sectors can vary.
We can be wrong in our prediction that CEF IPO’s are never more profitable when purchased at a later date. They key is that we were often correct. It is worth noting the January 2012 DoubleLine Opportunistic Credit Fund (DBL) IPO as an example.
We recognize that our research focused on the average experience for the average fund and some funds are actually successful at never breaching NAV and holding a premium. The January 27,2012 IPO of DBL is a perfect example. Its lowest premium has been +4.01% since IPO and has never breached its IPO price of $25 per share. In our experience it is always possible to find exceptions to the rule or common experience, but investors should be cautious when they buy a CEF IPO. They are far less likely to lose a large amount of capital, but they are unlikely to do better than waiting a few months for better pricing. One thing we can’t stress enough for CEF investors is doing your homework and being patient and diligent in your research and portfolio management.
Disclosures: This article was researched and written by Andrew Pavloff, a Senior at The College of William and Mary who is currently an extern with Closed-End Fund Advisors and was supervised by John Cole Scott.
The information and statistical data contained herein have been obtained from sources that Closed-End Fund Advisors (CEFA) believes are reliable, but CEFA makes no representation or warranty as to the accuracy or completeness of any such information or data and expressly disclaims any and all liability relating to or resulting from your use of these materials. The information and data contained herein are current only as of the date(s) indicated, and CEFA has no intention, obligation, or duty to update these materials after such date(s). These materials do not constitute an offer to sell or the solicitation of an offer to buy any securities. CEFA may make decisions for its clients in certain of these securities. CEFA and/or their respective officers, employees, and affiliates may at any time hold positions in any of these securities and may from time-to-time purchase or sell such securities.
John Cole Scott, CFS
Closed-end bond funds continue to gain a lot of attention as investors search for yield in a very low interest rate environment. At Closed-End Fund Advisors, we do our best to educate investors on how to avoid some of the big closed-end fund mistakes and this article is an effort to continue that endeavor.
We also are replying to Steven Pikelny’s article last week on the Morningstar “CEF Weekly” comparing Undistributed Net Investment Income (UNII) to body fat – essentially saying that: UNII balances for CEF bond funds are a tax liability, UNII is irrelevant for municipal funds and that the UNII trend “is a functionally useless metric, and muddles the overall point.” I have to whole heartily disagree with this statement. We suggest you read his article in order for ours to make sense. Read more…
“Crash Course in Closed-End Funds”
CFA Society of San Francisco
February 5, 2013 – 77 Minutes
Slides and Audio Reply for CFA San Francisco Keynote.
We are happy to share the information we presented last week. Please let us know if you have any questions.
By: John Cole Scott, CFS
Portfolio Manager, Executive Vice President
It was my pleasure to moderate the “Closed-End Fund Activism” panel January 22 in New York at the 4th Annual Activist Investment conference. The panelists were Andrew Dakos from Bulldog Investors and Art Lipson of Western Investment, both very well known in the world of closed-end fund activism. We were joined by Warren Antler, from AST Fund Solutions as Art was running late and we welcomed his addition as an expert in CEF activism from the proxy solicitation perspective.
Closed-end fund activism is similar to regular corporate activism except it is typically focused solely on both the short and long-term ways to close a significant discount to net asset value (NAV). This is usually done through tender offers, share buy-backs, management changes, adding or removing members of the board of directors, open-ending, or liquidation of the fund at NAV. The goal of the activist investor is to make the extra alpha gained from the narrowing of the discount or shares tendered close to NAV.
Andrew Dakos joined Bulldog in 1999 and co-manages the firm’s investment strategy. He has serves as a director for The Mexico Equity & Income Fund. He serves as a Principal of Brooklyn Capital Management, a Registered Investment Adviser and is President of Special Opportunities Fund (SPE).
Art Lipson is the Managing Director of Western Investments. He managed the fixed-income research departments at various Wall Street firms. He created the Lehman Brothers Bond indicies in 1973 and retired from Wall Street in 1985.
Warren Antler is Vice President, CEF Specialist at AST Fund Solutions. He has distributed a monthly dissident tracking and corporate action report on CEFs since 2003.
JCS: Good afternoon. I have some prepared questions. We also have planned plenty of time for your questions. Do you want to start Warren? Read more…
Closed-end funds continue to be a great place to find yield, with the average municipal bond CEF yielding 5.4%, taxable bond fund yielding 7.1% and equity fund yielding 6.6% on average as of January 25, 2013. While these yields are attractive, investors should learn how to reduce the risk of a dividend cut in a CEF.
Closed-End Fund Advisors started tracking two new data points we thought would help us select and compare dividend risk for a closed-end fund. They are Undistributed Net Investment Income Trend (UNII) and Earnings Trend. By taking the slope of the last three UNII and earnings figures for a fund, a trend is determined as “up”, “flat” or “down”.
When CEF collects dividend and bond income and pays a regular dividend to shareholders, it reports UNII as a line item on its balance sheet. If a CEF increases its UNII balance, it has more reserves on hand to possibly distribute as a dividend. Increases in earnings also gives the potential that a fund could be increasing its dividend level in the near future. When these figures are in line with each other (i.e. both earnings and UNII trends are positive or both negative), it makes a stronger case that either the fund is increasing or reducing its future income production. This, in our experience, makes it more likely that the Board may alter their dividend policy accordingly. Read more…
January 8th, 2013 – 65 minutes
Closed-End Fund Advisors, Inc.