1987 was a banner year for closed-end investment funds. More than three dozen of these vehicles were started, and raised some $10 billion. After what happened in October, one would think 1988 would be fairly quiet. One would be wrong.
Since Nov. 1, 30 new closed-end funds have been started, and they have raised $11.9 billion, according to Herzfeld & Co., a Miami money management firm that specializes in closed-end funds.
Unlike the far more common open-end mutual funds, where more shares are created every time new money comes in from investors, closed-end funds keep the same amount of shares and are traded on major stock exchanges, like company stocks.
There is a difference that reflects what happened on October, however. Like most other investments, the new crop of closed-end funds is following a cautious route, away from stock, or equity, funds and toward bond funds.
``Most of the funds are intermediate and short-term bond funds, and municipal bond funds,'' says Thomas Herzfeld, president of the company that bears his name. ``That seems to be what underwriters are able to sell. Equity funds really petered out after the crash. The only new equity funds that I can think of that were started after the crash were a few single-country funds.''
One thing that hasn't changed is the way closed-end funds are sold. While shares of open-end funds are continuously sold by brokers and by the funds themselves, closed-end funds tend to be one-shot deals: In the first few months after a new closed-end fund is issued, brokers work hard to sell them, and to collect the commissions. After that, the funds - and their investors - are on their own.
``You have a lot of brokers calling people,'' says Douglas Dent, publisher of Closed-End Fund Digest, a newsletter in Santa Barbara, Calif. ($200 a year; four-month trial for $60. 800-344-3789).
``So there's heavy promotion. But as soon as they get sold and they're in the marketplace [the brokers] don't really care any more, because shares are no longer being issued.''
``People are going for closed-end funds because that's what the brokers are selling right now,'' says Stephen Monheim, executive vice-president at Butcher & Singer Inc., a brokerage in Philadelphia. ``It's an easy story for the brokers to tell.''
The story these brokers tell is of an investment opportunity in a specialized area, like stocks from a particular country, bonds or stocks of a promising industry, or a fund managed by a well-known and successful manager, like John Templeton or Martin Zweig.
``Closed-ends are better because the money manager has the money and doesn't have to worry about liqidations,'' Mr. Monheim says. With an open-end fund, managers have to keep a certain amount of cash on hand to pay investors who can sell, or liquidate, their shares at any time. But since no new shares of a closed-end fund are issued, that's not necessary and the manager always has the same amount of money to work with, plus any gains from the investments in the fund.
On the other hand, Monheim notes, not having new money coming in limits a manager's ability to respond to new investment opportunities, and ``they should be in some cash for a lot of the time anyway.''
The most controversial difference between open-end and closed-end funds involves what happens after all the shares of a closed-end fund are sold. Although no new shares are created, investors can still buy into them through the stock exchanges. And although open-end funds are always bought and sold at full net-asset value, or share price, closed-end funds eventually are traded at a premium or, more often, at a discount to their net-asset values.
The average discount in funds today is 12.4 percent, Mr. Herzfeld says. In bond funds, the discounts are smaller, from 2 to 4 percent. Herzfeld has long recommended trading on the discount, buying when the discount is large and selling when it is small. When a closed-end fund's selling price is close to its net-asset value, he believes, it is fully valued and should be considered near its peak.
This way, he explains, an investor gains on both the shrinking of the discount and from any gains in the stocks or bonds in the portfolio.
The discount is also a reason he recommends against buying any new closed-end funds, since their share prices will almost certainly fall to discount territory after the brokers have sold all the new shares.
Even though this year's crop of closed-end bond funds is being sold on the basis of more caution, they're not without risks of their own.
``It should be made clear that there's a market risk with these funds as well as any type of investment,'' Monheim says. ``You've got to be aware that the bond market can drop.'' When it does, lower prices for the bonds in a fund's portfolio can wipe out any gains.
``But these are long-term investments,'' he adds. ``As long as the fund is paying the yield that you need, that's what the fund is supposed to do. These funds should be held for at least five to seven years. They are not to be traded.''