Closed-End Funds Seeing Consolidation

A wave of consolidations and outright liquidations is shrinking the number of traditional closed-end funds as investment companies look for ways to economize in a more challenging market.

Fund companies either consolidated or liquidated 27 closed-end funds through the end of October. That's up from 20 during all of 2017, according to the FundMarket report by Lipper Research.

Possibly the biggest factor is a desire to cut back on overhead expenses at a time when most CEFs (closed-end funds) are reporting a decline in net asset value amid a rocky stock market.

But larger funds may also provide fund companies struggling to thwart activist investors with a harder-to-manipulate target as well, experts say.

And mergers and consolidations can also provide a boost to investors, who can get a bump when another fund buys up the CEF they have money in.

Consolidations can be "beneficial because costs to run the fund come down, and the remaining fund is more larger/more liquid," says Gregory Neer, partner at Relative Value Partners in Northbrook, Illinois.

Too small to compete?

Closed-end funds hold a modest but influential niche in the overall fund world, managing roughly $300 billion in assets.

They differ from their far more numerous cousins in the open-end mutual fund world in their fixed capital structure and the fact they are traded on exchanges throughout the day.

This combination creates gaps between the closed-end fund's trading price and the net asset value of its holdings, often allowing investors to buy the stocks and bonds in the portfolio at a significant discount.

Closed-end funds also have the ability to borrow and use leverage to boost returns, something open-end mutual funds can't do, and are often actively managed, paying for investment talent.

However, while closed-end funds remain popular, market pressures have resulted in a wave of consolidations and mergers, with funds that cover similar, highly specific niches in sectors that are lagging or experiencing turbulence often prime targets now.

Just take the emerging market sector, whose performance gap with U.S. markets has widened dramatically in the past few months amid trade tensions with China and other concerns.

Aberdeen Asset Management Inc. rolled out plans last month to combine six different funds -- covering Latin America, small companies in emerging markets, Israel, Indonesia, Singapore and "Greater China" -- into a seventh fund focused on Chile.

The Aberdeen Chile Fund, Inc., which was officially the acquirer of the other six emerging market funds, has since been renamed the Aberdeen Emerging Markets Equity Income Fund, Inc.

And Aberdeen's newly enlarged emerging markets fund is hoping to grow even larger through additional acquisitions.

"We welcome inquiries from other closed-end funds whose shareholders may be attracted to an emerging markets equity income strategy about joining the consolidation," according to a statement by the chairman of Aberdeen's new emerging market fund.

Owners of the Asia Pacific Fund have taken a different route, opting to liquidate its holdings and shut down. The fund, first launched in 1987, announced in early November that it would cease operations this coming February.

The fund's top holdings, at the time of its annual report in March, included a Chinese construction bank and a major Chinese developer focused on building out properties across the country.

While the fund remained bullish about the long-term investment prospects of its target markets, it noted the decision to liquidate was being driven by the fund's institutional investors.

"The near-term market pull back presents long-term investors with a chance to gradually accumulate China-related stocks," the Asia Pacific Fund noted in its final annual report.

With the Fed hiking interest rates, closed-end municipal bond funds have taken a hit. Municipal debt CEFs posted their second month of declines in net asset value in October, averaging a 1.26% drop.

Against the backdrop of this challenging market, BlackRock Advisors over the summer consolidated two New Jersey municipal bond funds into a third fund, the BlackRock MuniYield New Jersey Fund. The move enabled BlackRock to shed two funds, the New Jersey Municipal Bond Trust and the New Jersey Municipal Income Trust.

Warren Ward, a certified financial planner with WWA Planning and Investments in Columbus, Ind., notes that combining two or more funds with similar investment strategies is a way to spread the overhead costs "over a wider ownership base."

"Mergers usually happen within families when a fund, (or a couple of similar funds) are no longer pulling their own weight," notes Ward, who focuses on closed-end bond funds.

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