Style Drift in Closed End Funds

riskIn my view, Closed End Funds (CEF) are very similar to mutual funds with 1%+ of expenses, and many are actively managed. The difference lies in trading and not able to create new units. When I started investing few years back, in income domain, I was attracted by high yields. While I got rid of quite a few CEFs, I still continue to hold IIA, IGD, and AOD.

Among others, one of the issue with these funds (for which I get annoyed) is the way the fund managers drift away from objectives and execution strategy. Investors continue to remain invested under the impression that fund managers are continuing to stick to the originally stated objectives. Furthermore, there is nobody to question these managers. The whole premise of using actively managed funds (including CEFs) is that managers will keep up original objectives and use their skills for reducing downside risk. Let me discuss two examples:

  • AOD: Originally, one of the objectives of the fund was to look for best dividend opportunities around the globe. In doing this, it will focus on dividend income and long-term growth of capital. When I had bought the fund, it had approximately 65% invested in international companies (i.e. Europe, Asia, South America, Australia, etc). As the downturn began, in my opinion, the fund managers fail to grasp or anticipate the potential risk to its funds. Keeping with its holding companies, dividends very reduced. In addition, the funds underwent changes. The fund drifted and now has 50%+ of US investments. As other growth or emerging markets recovered, AOD missed the bus, because its most of the holdings were in US. Basically, fund managers get paid for doing nothing!

  • IIA: This is one my buys from yield chasing days. The fund focus was to invest in US REITs and provide regular monthly income. With the downturn, this fund was almost a toast. Dividends became a trickle. And now the fund has been merged with another fund IGR (with similar objectives but for global market). The notion that nobody saw it coming does not justify the failure. Again fund managers get paid for doing nothing!.

The point is as individual investors, we just do not have visibility into the funds operations. We do not know when and how the funds gets away for its original strategies and objectives. This is another reason to invest in ETF (instead of CEFs) which are following certain index and are likely to stick to it.

2 Responses to “Style Drift in Closed End Funds”

  1. tinman says:

    What bugs me about funds is the lack of data. What is the weighted average P/CF? What is FORWARD weighted P/E ? How much is the current weighted payout ratio? Pretty fundamental questions easily answered with any US traded equity but difficult if not impossible to find for any given fund.

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