Douglas G. Ober, Chairman, Adams Express Company and Petroleum & Resources Corporation President, Closed-End Fund Association

The dawn of a new year permits us to reflect on the closed-end fund industry in 2002 as we head into 2003. The equity markets continued to struggle; the S&P 500 ended the year down a punishing 22.1%, marking the first time since the late 1930’s that the market ended three consecutive years in negative territory. The last year tested the mettle of every investor, including the portfolio managers of the more than 500 closed-end funds that make up our industry. During the year, we saw a handful of funds merge, liquidate, or convert to an open-end structure while the rest of us did our best to ride out the stormy markets. And the reduction in the number of brokerage firms that provide analyst coverage of our industry suffered a blow when Merrill Lynch let its closed-end fund analysts go.

The news was not all bad for closed-end funds, however. There were a number of bright spots, including the creation of many new fixed-income funds, a modest narrowing, on average, of discounts, and stronger cooperation among the members in our industry to coordinate efforts to get our message out. To increase transparency for investors, recent industry efforts have encouraged funds to report their NAVs daily. These efforts have resulted in over 93% now reporting NAVs daily, according to Lipper, thus increasing information that benefits shareholders.

Discounts narrowed ever so slightly during the year. According to Don Cassidy at Lipper, annual net overall movement was minor and the median closed-end fund discount narrowed slightly to 10.1%, down from 11.6% in 2001. Cassidy predicts that value may continue to find more popularity than growth in 2003. This would create a neutral to mildly positive environment for equity-fund discounts/premiums in the year ahead.

2002 was the best year since 1993 in new issues, providing strong evidence of vitality in the closed-end fund arena. Seventy-three funds had initial public offerings through November, raising a total of nearly $15 billion in assets. Why the sudden flurry of new issue activity? Many closed-end income funds were issued because the closed-end structure allows portfolio managers, particularly those managing fixed-income portfolios, to do what traditional mutual funds cannot: use leverage to capitalize on a period of declining interest rates. Mariana Bush, the closed-end fund analyst at Wachovia Securities, has published a thoughtful report entitled Leverage among Closed-End Funds dated December 9, 2002, that appears on the CEFA website. She points out that funds may invest assets at a higher rate than the borrowing rate, thus enhancing the yield to shareholders. Municipal closed-end funds, for example, leverage their assets by issuing preferred stock, while high yield funds borrow assets in the form of a loan. Leverage is a portfolio feature that comes at the expense of increased net asset volatility, according to Bush, but that volatility can be welcome in a declining rate environment. The effect of leverage on a fixed income fund may be positive in a declining interest rate environment, but negative during periods of rising interest rates, Bush reports.

Rights offerings also continued to get done during the year. In a current report, Lipper reports that rights offerings were equal in number (although lower in total dollars raised) to a year earlier, which is notable given the difficult market conditions domestically and worldwide.

Closed-end funds have endured up and down markets throughout most of the last century. The first closed-end fund predated by more than 30 years the first mutual fund formed in the United States. Currently, there are more than 500 closed-end funds totaling $146 billion in assets, including a strong contingent of funds whose performance histories date back over 50 years. In fact, six funds that were created during the 1920’s are still serving the investing community: General American Investors Company, Tri-Continental Corporation, Central Securities Corporation, Salomon Brothers Fund, Adams Express Company, and Petroleum & Resources Corporation. Some market followers have dubbed this group of venerable funds “the Class of 1929.” My two funds are proud to be members of that group.

Closed-end funds will ride out the challenges ahead and will continue to be attractive to the next generation of investors, who value active management by outstanding portfolio managers, diversification and the liquidity that these funds have offered since the early part of the last century.  

2002 Summary of Closed-End Fund Performance

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