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Closed-End Funds  Download PDF
March 31, 2008
We are pleased to share with you our review and outlook for the closed-end fund market as of March 31, 2008. In the first quarter, the market price total return of the Fund Data U.S. All Taxable ex-Foreign Equity Closed-End Fund Index was –3.9%, while its return on net asset value (NAV) was –6.0%. By comparison, the S&P 500 Index and the Lehman Brothers Aggregate Bond Index had total returns of –9.5% and 2.2% for the quarter, respectively.
Investment Review
Closed-end fund total returns were volatile during the first quarter as recession worries, lower corporate earnings forecasts and continued fallout from the credit crunch put pressure on the prices of their underlying securities.
A sell-off triggered by failed AMPS auctions
Fund discounts to net asset value (NAV) narrowed in January as investors reentered the market following tax-loss selling in 2007. Discounts widened and fund shares sold off in February, however, when the market for auction market preferred securities (AMPS) stalled. Many closed-end funds issued AMPS—perpetual securities with dividend rates that reset at weekly or monthly auctions—as part of a yield-enhancement strategy. Late in the quarter, net asset value discounts narrowed as investors were attracted to the superior yields on closed-end funds compared with other income-oriented alternatives.
A flight to quality as investors shun risk
Financial and total return closed-end funds declined during the period, reflecting the poor performance of the equities in which they invest. Senior loan funds also fell, amid the volatile credit environment. Global income, covered call debt, emerging market debt and government funds were the best performers, as investors gravitated either to safer asset classes or to those likely to benefit from the decline of the U.S. dollar.
Our portfolios trailed the benchmark for the quarter. Overweight positions and stock selection in the total return and tax-advantaged dividend fund groups detracted from performance. Our underweight positions in emerging market debt and U.S. government bond funds, and decision to not invest in global income closed-end funds also hurt performance, as these were among the best performers for the period.
Our underweight position in senior loan and an overweight position in real estate investment trust (REIT) closed-end funds helped performance
Investment Outlook
Although the U.S. economy has slowed, we believe conditions for equities are relatively favorable compared with previous downturns. Employment levels are high by historical standards, corporate balance sheets are strong and U.S. companies have been investing productively in overseas markets. We expect to see earnings growth in the single digits—the high single digits, if financial companies are excluded from the mix.
Closed-end fund share prices and net asset values are likely to be volatile until there is a long-term solution to the AMPS market crisis. That said, we believe the groundwork has been laid for a recovery in fund share prices. The federal funds rate now stands at 2.25%, down from 4.25% in January, and the federal government has introduced a $160 billion fiscal stimulus package aimed at jump-starting the economy. We believe that closed-end funds, which historically have had strong total returns in the year following bear markets, should be poised to benefit from a reaccelerating economy.
The views and opinions in the preceding commentary are as of the date of publication and are subject to change. This material represents an assessment of the market environment at a specific point in time, should not be relied upon as investment advice and is not intended to predict or depict performance of any investment.
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