Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN - Closed End Funds

A. Sure. And I always want to start by defining what a CEF is, since thereis a shorthand definition out there that is really not correct.

Q. Okay, so what is the proper definition of a CEF?

A. A CEF is a registered investment company, regulated under the InvestmentCompany Act of 1940 (just like a mutual fund), that does not stand ready toredeem its shares every day the NYSE is open for business.

Q. We often hear they are traded on a stock exchange and have a fixednumber of shares...

A. Well, more than 90% of CEFs in the USA do trade on exchanges, but somedo not; those offer usually quarterly redemption tender offers. And almostnone have a fixed number of shares, since dividend reinvestment programs(DRIPs) are common.

Q. How many CEFs are based here in Colorado?

A. Just five at present: the Blue Chip Value Fund (BLU) managed by DIA, theDelaware Investors Colorado Insured Muni Bond Fund (VCF), and the BoulderTotal Return (BTF) and Boulder Growth & Income (BIF). The newest additionis the Denver-based Dividend Realty Income Allocation Trust (DCA), whichowns real estate securities; it had its IPO in February 2005. The samemanagement company is now in registration for another fund, which will ownboth real estate equity and debt.

Q. Okay, what has been going on in the past year in CEFs?

A. The number of CEFs (without counting extra classes of shares in a few)has hit an all-time high of about 640, and the common shareholder assets inthe funds have also made a new high of about $230 billion as of year's end.

Q. Were there a lot of new CEFs that did their IPOs in 2005?

A. It was not a huge year for IPOs, actually; 38 new funds came to market,which was down from 50 in 2004. And the assets raised were $16.4 billion,down from $22.8 billion a year earlier. The assets raised were still thethird most ever, though.

Q. Why was issuance down, do you think?

A. A couple of factors were at play... the U.S. dollar was rising rather thanfalling, and that made new world equity types of funds less easy to sellthan would have been the case in 2003-04. And with the interest rate curvepretty flat, the ability to create CEFs that could pay a high yield becauseof leverage was impaired. And a lot of these do sell on yield.

Q. So, was there some common theme as to the types of new funds that didcome out?

A. Definitely. And the words were "dividends" and "options."

Q. So, investors were still in love with current dividend income ratherthan hopes for big growth?

A. Exactly. And with the stock market mainly going sideways and being alittle frustrating, a way to enhance income was through the buy-and-writeprocess: a fund buys stocks and writes call options against them to getextra income.

Q. So, was that the biggest theme of the year, then?

A. Absolutely: 20 of the 38 new funds were the option-writing type,including a few for overseas stocks. The largest CEF ever to be issued wasof this kind and it raised just over $2 billion!

Q. How have those funds worked out?

A. Somewhat predictably, all of them are now trading at discounts to NAV.They went to deeper discounts at the end of December (tax-loss sellingseason) but have recovered some in the past few weeks.

Q. Tell us about the current discount-versus-premium situation.

A. Sure. Since most CEFs trade on the stock market, their trading or marketprice is set by supply and demand, and that price will not usually beexactly the same as the underlying NAV per share. Lipper supplies thetables for the Wall Street Journal, New York Times, Barron's, and otherpapers, and for the online tables showing the premiums and discounts on theWSJ interactive site.

Q. And are most CEFs at premiums or discounts to NAV now?

A. Right now about 76% are at discounts. The median discount is about 5.8%,which is not very extreme by historical standards.

Q. What kinds of CEFs are at the most interesting discounts?

A. Real estate funds (which mainly hold REITs) are at about an 11.6%discount; preferred-stock funds at about 9.4%, loan-participation funds atabout 7.5%, and world income (bond) funds at about 6.7%. If the dollarshould weaken again, the world funds would benefit in both NAV and discountterms.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).