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Info on closed-end funds scarce – but advisers hawking them anyway

Close to half of survey respondents who recommend the mutual funds to clients dubbed available research ‘inadequate.' What's wrong with this picture?

Apr 28, 2011 @ 3:33 pm

By Jeff Benjamin

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Financial advisers are hungry for more research on closed-end funds. Apparently, though, that dearth of information is not so great that it prevents some advisers from still selling the products to their clients.

This is among the takeaways from a recent survey of 800 advisers across a range of wirehouse, regional and independent brokerage channels.

According to the research, which was conducted in March on behalf of Aberdeen Asset Management Inc., roughly two out of three advisers polled who recommend closed-end funds to their clients said they would like to receive more information on the products.

Also, among those advisers already recommending closed-end funds, 61% said access to expanded research would increase their recommendations.

Perhaps more distressing, the results show that 44% of advisers who recommend closed-end funds feel that the information they receive on the products is “inadequate.”

This doesn't exactly scream confidence on the part of those advisers selling closed-end funds. In fact, if an adviser can admit to needing more information on a product perhaps that adviser shouldn't be recommending it to a client.

We already know that virtually all closed-end funds are sold at their initial public offerings directly to retail clients, where investors are charged commissions of around 5%, which triggers the first separation between the fund's share price and its underlying net asset value.

For example, if a share of a closed-end fund is sold for $10, the broker and the underwriter will take about 47 cents in the form of a commission, leaving the fund manager with $9.53 to manage.

This means that right off the bat investors are paying $10 for $9.53 worth of net asset value in the portfolio.

“I wouldn't do business with any adviser or any firm that tried to sell me a closed-end fund at the IPO,” said Scott Miller Sr., chief investment officer at Blue Bell Private Wealth Management LLC, which manages $280 million.

Mr. Miller does invest in closed-end funds for his clients but he only buys them on the secondary market and only when they are trading at a significant discount to net asset value.

Unlike open-end mutual funds, the shares of a closed-end fund trade are priced independently from the underlying assets.

One of the ways that Mr. Miller navigates the market is by identifying discounts to NAV that are above historical averages, because he is assuming an eventual reversion to the mean.

General American Investors Company Inc. Ticker:(GAM) is one example. The fund is currently trading at a 15.2% discount to its NAV, which compares to a 52-week average discount of 14.5%.

An even more extreme example is the Eaton Vance Tax-Managed Diversified Equity Income Fund Ticker:(ETY), which is trading at an 11.2% discount, compared to a 52-week average discount of 4.1%.

“I love closed-end funds, but I only buy them when they're trading at a high discount to NAV,” Mr. Miller said.

To be fair, the Aberdeen survey results didn't break out whether the advisers were selling clients funds at the IPO or through the secondary market.

According to Piers Curie, Aberdeen's global head of marketing, less than 4% of the survey respondents only buy closed-end funds for the their clients at the IPO.

“I think there's a lot of activity in the secondary market,” he said.

Of course that doesn't change the fact to the closed-end fund industry relies almost exclusively on commission-based reps to introduce the funds to the market through individual investors.

Aberdeen Asset Management, which manages $52.8 billion in the United States, is a wholly-owned subsidiary of Aberdeen (Scotland) Asset Management PLC, which has $287 billion under management.

The company manages about $6 billion in closed-end funds, including some funds that date back to the 1870s..

From Mr. Curie's perspective, the industry would benefit from more third-party research along the lines of the dedicated closed-end fund research offered by Morningstar Inc.

He emphasized that the survey results do not necessarily suggest that advisers are giving poor advice with regard to closed-end funds, but they do want more information.

“A lot of it is about things like increasing the frequency of reporting,” he said. “Some of the managers are only providing quarterly reporting.”

Mr. Miller contends that there is plenty of information already publicly available on closed-end funds, “but you have to know how to use it.”

“Gathering the information is the issue for a lot of advisers,” he added. “The information is there, you just have to put it together.”

Mr. Miller recommended, run by closed-end fund manager Nuveen Investments LLC, as one of the best resources for closed-end fund industry research.

According to the survey results, more research – or research that is easier for advisers to find and navigate – could lead to even greater sales of closed-end funds.

The report stated that 53% of advisers who do not currently recommend closed-end funds do not do so because they feel there is a lack of research on or knowledge about closed-end funds.

“The most illuminating result of the closed-end fund survey is that more than 75% of financial advisers are hungry for additional research coverage and/or increased communications from sponsoring asset management firms and other parties,” Gary Marshall, head of Americas at Aberdeen said in a published release.

It was probably not Mr. Marshall's intention in his statement, but part of what makes that hunger for information so illuminating is that most of the hungry advisers are already selling closed-end funds to their clients.


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