INVESTOR TAX-TRADING OPPORTUNITIES AND DISCOUNTS ON CLOSED-END MUTUAL FUNDS

Discounts on closed-end mutual funds are a puzzle to financial economists, because arbitrage activities should eliminate discounts in a perfect capital market. In this paper I develop a model that explains discounts, using Merton's option pricing theorem. By holding shares of a closed-end mutual fund, investors lose valuable tax-trading opportunities associated with the constituent securities of the closed-end mutual fund's portfolio. However, investors can take advantage of all tax-trading opportunities by directly holding the closed-end mutual fund's portfolio. I also show that both variances of individual securities and correlations among securities in the portfolio are important factors in determining the magnitude of discounts.     

A RE-EXAMINATION OF THE RELATIONSHIP BETWEEN CLOSED-END FUND DISCOUNTS AND EXPENSES

In this paper the role of expenses in explaining closed-end fund discounts is re-examined. A present value model is developed to illustrate the relationship between expenses and discounts. Earlier studies find that discounts are not related to management fees. In this paper, using a larger sample over a longer and different period and a better specification of the expense variable consistent with the model developed, discounts are found to be significantly related to expenses. The relationship between expenses and discounts holds in the presence of other control variables.     

PRICE PRESSURE AND THE ROLE OF INSTITUTIONAL INVESTORS IN CLOSED-END FUNDS

A trader-identified transactions database is employed to investigate: (1) the relation between order-flow imbalance and closed-end fund share prices and discounts; and (2) the role of institutional investors in closed-end funds. Empirical results are consistent with the hypothesis that buyers (sellers) of closed-end funds face upward-downward-) sloping supply (demand) curves. The results also demonstrate that ownership statistics do not accurately reflect institutional investors' importance in the closed-end fund market. The results fail to provide evidence that institutional investors offset the positions of individual investors or that institutional investors face systematic “noise trader risk.”     

A POSSIBLE RECONCILIATION OF SOME OF THE CONFLICTING FINDINGS ON CLOSED-END FUND DISCOUNTS: A NOTE

The most obvious explanation for the closed-end fund puzzle, the existence of managerial contribution (i.e., managerial performance less managerial fees), has been called into disrepute because of the inability of researchers to consistently document a negative relationship between such benefits and discounts. We present a model which shows that it is possible to account for some of the stylized facts without abandoning market efficiency and rationality. It is suggested that when one takes into consideration the impact of managerial contribution on the probability of open-ending, a negative relationship between managerial contribution and discounts actually may result.     

THE PERFORMANCE OF UK CLOSED-END FUNDS: A COMPARISON OF THE VARIOUS RANKING CRITERIA

This study considers the performance of UK Investment Trusts over the ten-year period 1968 to 1977, using the major criteria suggested in the literature. The results indicate that UK closedend funds were generally inferior (ex post) to the market portfolio (FT Actuaries All-Share Index). These findings were invariant to the particular peiformance methodology selected. When the overall test period was broken up into sub-periods it was also found that the ex post performance findings were not particularly stable or consistent over time. These results highlight the problems a fund investor would face in attempting to predict future fund performance on the basis of historical results.     

MUTUAL FUNDS SELECTION BASED ON FUNDS CHARACTERISTICS

The popular investment strategy in the literature is to use only past performance to select mutual funds. We investigate whether an investor can select superior funds by additionally using fund characteristics. After considering the fund fees, we find that combining information on past performance, turnover ratio, and ability produces a yearly excess net return of 8.0%, whereas an investment strategy that uses only past performance generates 7.1%. Adjusting for systematic risks, and then using fund characteristics, increases yearly alpha significantly from 0.8% to 1.7%. The strategy that also uses fund characteristics requires less turnover.     

THE COUPON EFFECT ON TERM PREMIUMS

Monthly holding period returns for U.S. Treasury bills and notes of identical maturity indicate a significant coupon effect upon term premiums. Hotelling's T² test of the vectors of mean term premiums indicates that term premiums are not statistically significant for notes but are significant for bills. Mean-variance and stochastic dominance criteria indicate an investment preference for bills over notes on a pretax basis. Because the data set is Treasury bills and notes, which are identical except for coupon level, these results are evidence of a coupon effect on term premiums.