Although mutual funds have pretty much always been popular and ETFs have begun to rapidly gain ground, one corner of the fund world has not seen its status surge; the closed-end fund space. These close cousins of ETFs invest in a number of securities like exchange traded funds but there are a few key differences. First, the closed-end aspect means that only a certain number of shares are created and once those are sold that is (generally) it. Not so in the ETF world as more shares are always being created or destroyed in order to match investor demand.
This important difference results in two key distinctions between ETFs and CEFs. First, the lack of easily available shares can greatly cut down on trading volumes, making most CEFs very illiquid investments. In fact, the Eaton Vance Tax Advantaged Global Dividend Income Fund which is a popular CEF that has about $1 billion in AUM, trades less than a quarter million shares a day, suggesting that even less popular funds will also have a difficult time getting trading volumes high (India ETFs: Behind The Crash).
Thanks in part to this lack of volume, CEFs can often trade at steep discounts to their underlying NAV. However, it should also be noted that these funds can also trade at heavy premiums, assuming of course that investor demand is sufficiently more than the number of shares currently on the market. Once again, this is in contrast to ETFs as the ability for authorized participants to create and destroy baskets of shares helps to keep ETFs trading reasonably close to NAV in most cases. So clearly while ETFs and CEFs have some similarities, there are a number of differences that ensure these two products are viewed as two completely different types of funds.
Despite these differences, PowerShares has attempted to bridge the gap between the two spaces with the recent launch of the CEF Income Composite Portfolio (PCEF - ETF report). The fund could help to bring the liquidity of the ETF world to the Closed-End Fund space while also giving more investors exposure to the CEF world in basket form. This could help alleviate the worries of some who were skittish about buying a particular CEF but would not have any qualms about investing in a number of these products in order to tap into their benefits from both a yield and a diversification perspective (also read Australia Bond ETF Showdown).
PCEF Under The Microscope
PCEF tracks the S-Network Composite Closed-End Fund Index which is a benchmark of closed-end funds. As such, PCEF is a ‘fund of funds’ as it invests its assets in the common shares of funds included in the Index rather than in individual securities. Currently, the benchmark includes closed-end funds that invest in taxable investment grade fixed-income securities, taxable high yield fixed-income securities, and others that utilize an equity option writing strategy (see Inside The SuperDividend ETF).
At this time, the portfolio consists of about 125 securities with a nice mix between bonds (46%), high yield fixed income (20%) and option income (34%). Top holdings include the aforementioned ETG along with the AllianceBernstein Income Fund and the Eaton Vance Limited Duration Income Fund . Thanks to the focus on high yielding securities, the payout for PCEF is pretty solid, giving investors a 30 Day SEC Yield of 8.6%, a figure that should definitely turn some heads in this low rate environment.
The only downsides for PCEF are its relatively high fees and the somewhat low level of liquidity. The fund trades about 80,000 shares a day so tight bid ask spreads are not assured by any means. In terms of fees, the fund charges half a percent for its management fee, which is entirely reasonable for this type of specialized product. However, there are significant costs related to the expense ratios from the CEFs themselves in what are known as ‘acquired fund fees and expenses’. These costs come in at 1.12% a year and help push the total expense ratio up to about 1.62%, putting the fund at the high end of the ETF range (also see HDGE: The Active Bear ETF Under The Microscope).
Nevertheless, the product remains one of the few basket options for investors seeking exposure to the CEF world, and the suburb yield should be more than enough to cover the lofty expense ratio for most investors. This is especially true if one is unwilling to look at Van Eck’s (XMPT - ETF report) which tracks closed end funds with a special focus on leverage. XMPT is still relatively new, however, and the fund has failed to attract a reasonable level of assets at this current time (under $5 million AUM at last count). Thanks to this, many will probably be better off sticking with PCEF for CEF exposure, unless of course you have a particular interest for the muni bond market and are not too concerned about loose bid ask spreads. Either way, both securities could give diversified CEF access and can give exposure to a corner of the market that is largely untapped by most mainstream investors.
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