Closed-end funds: a style analysis of emerging, country, and global funds.

• Author: Charron, Marta
• Position: Report

1. INTRODUCTION

   Emerging, global, developed and pacific ex-Japan closed-end funds, in general, provide institutional as well as individual investors with the opportunity of investing in foreign assets. The fund shares are bought and sold in the U.S. markets, whereas their corresponding underlying assets are traded in foreign stock markets. Diversification benefits are also derived from the exposure to foreign markets.

   This paper examines the performance of closed-end funds that invest at least 25% of their holdings in securities outside the U.S., namely emerging, global, developed and pacific ex-Japan funds. Performance is examined using a style analysis (Sharpe 1992) where the regional exposure of the funds is estimated using daily returns and four factors representing investments in the emerging economies of Asia, Eastern Europe, Latin America, and an index for the cash holding of the funds. The manager's stock selection ability is also examined using a three factor model.

   A closed-end fund (CEF) is an investment company that holds or bundles other publicly traded securities. They operate in a way similar to any business corporation, but their corporate business consists largely of investing funds in the securities of other corporations and managing these investment holdings for income and profit. In contrast to an open-end mutual fund that issues and redeems shares directly with investors at net asset value (NAV), a CEF is usually listed on a national exchange, where its shares are purchased and sold in transactions with other investors, not with the fund itself. Closed-end funds usually follow consistently the stated objective, such as current income, capital appreciation or they invest in a particular region or country like the closed-end country funds, emerging market funds or global funds. The emerging markets funds (EM) seek long-term capital appreciation by investing primarily in emerging market equity securities, where "emerging market" is defined by a country's per-capita GNP or other economic measures. They are characterized as having high growth expectations with the possibility of high returns and high risk and volatility. EM markets are considered to be at an early stage of development.

   Developed market funds (DM) invest primarily in equity securities whose primary trading markets or operations are in countries (or a single country) outside of the U.S. that is generally considered developed. Global funds (GL) invest at least 25% of their portfolio in securities traded outside of the United States and may own U.S. securities as well. Finally, Pacific ex Japan funds (XJ) invest in equity securities with primary trading markets or operations in the Pacific region (including Asian countries) excluding Japan (Closed-end fund association, 2009). The shares of EM, GL, DM, and XJ funds represent claims to a diversified portfolio of assets in different countries.

   This paper contributes to the closed-end fund, emerging markets, global funds and country funds literature. The performance of closed-end funds, as an asset class, has not been studied as extensively as other assets. This paper will not only expand the closed-end fund literature but could also help fund managers in portfolio asset selection and allocation.

2. LITERATURE REVIEW

   Kim and Song (2010) investigate the cross-sectional relation between investment barriers and premiums of closed-end country funds (CECF) traded in U.S. markets over the period from 1995 to 2004. They find that funds investing in markets with higher indirect investment barriers have higher premiums. They also find that the relation between the country's risk and CECF premium is much stronger after the stock market liberalization.

   Jones and Stroup (2010) use the Economic Freedom Index (EFI) as a proxy for the degree of market segmentation and test whether closed-end country fund premiums can be partially explained by a country's EFI value which measures a country's institutional...