Closed-End Funds Slump Amid ETF Surge

"ETFs are primarily equity-oriented, while the average closed-end fund buyer is looking for income," says Mariana Bush, CEF analyst at Wachovia Securities.

Bush and others point out that there are only a handful of fixed income ETFs, compared with 457 bond CEFs at last count. And of the 178 equity CEFs, many use covered calls or leverage to increase yields, neither of which is available in an ETF.

Bush attributes part of the October selloff to investors unfamiliar with the CEF structure who sold when the market turned too quickly for them.

"There have been a lot of closed-end fund IPOs this year and their high yields have been catching peoples attention," says Bush. "But not all the buyers should have been in CEFs because they don't understand the risks associated with leverage."

Yield is not the only thing investors can't get from an ETF, says Greg Drake, managing director at Claymore Securities, a firm which oversees CEF assets of $12.5 billion. Drake says the typical CEF buyer is looking for active management, another property index-based ETFs can not offer.

"Every structure has its day," says Drake. "Passive investing is popular now, however, if the S&P Index maintains its trading range for much longer, then people will be looking for active management again."

To view a video take of Gregg Greenberg's mutual fund report, click here.