Recently in Closed-End Funds Category

December 10, 2013

Closed-End Fund IPOs Often Give Investors the Short End of the Stick

In last week's blog post about closed-end mutual funds [click here for blog post], I warned investors about paying a premium when investing in a closed-end fund's initial public offering (IPO) and suggested that the most prudent thing to do is invest after the IPO. According to the Closed-End Fund Association (CEMA), IPO fees generally range from 4.5%-4.75%.

Although closed-end funds offer liquidity, investors should view a closed-end fund IPO as a long-term investment. Most problems arise when closed-end funds are traded on a short-term basis. Of the six recently issued IPOs listed below, only the Goldman Sachs MLP Income Opportunities Fund is currently in positive territory, trading about 1% above its IPO price. However, since the Goldman fund began trading just two weeks ago, the jury is still out on how well IPO investors are going to fare both near-term and long-term. As mentioned in a previous blog post, investing in a closed-end fund IPO is almost always a losing short-term bet.

ClearBridge American Energy MLP Fund [CBA] (-18.20%)
IPO date 6/26/2013 @ $20/share. Today's opening price $16.36/share.

KKR Income Opportunities Fund [KIO] (-11.75%)
IPO date 7/26/2013 @ $20/share. Today's opening price $17.65/share.

THL Credit Senior Loan Fund [TSLF] (-12.10%)
IPO date 9/20/2013 @ $20/share. Today's opening price $17.58/share.

Center Coast MLP & Infrastructure Fund [CEN] (-15.15%)
IPO date 9/26/2013 @ $20/share. Today's opening price $16.97/share.

Ares Multi-Strategy Credit Fund [ARMF] (-16.84%)
IPO date 10/29/2013 @ $25/share. Today's opening price $20.79/share.

Goldman Sachs MLP Income Opportunities Fund [GMZ] (+1%)
IPO date 11/25/2013 @ $20/share. Today's opening price $20.20/share.

Related Links:

Investing in Closed-End Fund IPOs: A Risky Bet

FINRA Sanctions Merrill Lynch and UBS for Failing to Supervise the Sale of Closed-End Funds

December 4, 2013

Investing in Closed-End Fund IPOs: A Risky Bet

investor alert.gifLooking for higher returns often means looking for trouble. Some financial advisors seeking to offer investors higher yields have been turning to closed-end funds, which can offer distributions as high as 6%. Unsophisticated investors frequently confuse closed-end funds with standard mutual funds, referred to as "open-end funds." Closed-end funds are complex investment products that carry unique risks that may be inappropriate for more conservative investors. Last month, FINRA, the overseer of the financial industry, issued an Investor Alert urging investors to proceed with caution when investing in closed-end funds. (See "Related Links" below.) Unlike mutual funds, closed-end funds are typically offered through an initial public offering (IPO). After the IPO, closed-end funds trade like stocks. However, as FINRA noted in their alert, investors pay a premium when buying shares in a closed-end IPO. We blogged about this issue back in July 2009, based on a study by Lipper Research explaining that market prices for closed-end funds often plunge after the IPO. (See "Related Links" below.)

If you are still convinced that investing in a closed-end fund IPO is a good idea, read this post: Closed-End Fund IPOs Often Give Investors the Short End of the Stick

What is a risk-averse investor to do? Make sure that the fund is suitable based on your financial situation, risk tolerance and investment objectives. Although there is no guarantee that a post-IPO plunge will lead to a subsequent gain, consider investing after the IPO. Finally, if getting in on the closed-end fund IPO is simply to good to pass up, go in with the understanding that this should be a long-term investment that may take time before premiums paid at the IPO can be recouped.

Related Links:

FINRA Investor Alert: Closed-End Fund Distribution: Where is the Money Coming From?

July 2009 Blog Post: FINRA Sanctions Merrill Lynch and UBS for Failing to Supervise the Sale of Closed-End Funds.

July 29, 2009

FINRA Sanctions Merrill Lynch and UBS for Failing to Supervise the Sale of Closed-End Funds

Before discussing the Financial Industry Regulatory Authority's (FINRA's) latest action against Merrill Lynch and UBS, I want to share a related story about a client at my San Mateo, California, securities law practice who had invested a substantial part of her portfolio in a Closed-End Fund (CEF) that, unknown to her, was purchased as part of an Initial Public Offering (IPO). The client, who had recently been widowed, had made a large deposit in her brokerage account following the sale of her deceased husband's business. Needless to say, the widow wanted to proceed cautiously and preserve her capital. Unfortunately for the widow, the broker did not share with her the "dirty little secret" about investing in CEFs:

Customers who invest in Closed-End Funds at the IPO almost always suffer an immediate loss.

This came as a shock to the widow, but it is a well known fact within the industry and is supported by a large body of research going back over 20 years. The reason is simple. CEFs almost always trade at a discount to their Net Asset Value (NAV) in the secondary market. However, when an IPO is structured, the fund's offering price is typically set at or above the NAV. Thus, the fund's price usually plunges after the IPO when the shares begin trading in the secondary market. See e.g., Lipper Research Report, "Buying a Closed-End Fund Initial Public Offering: Caveat Emptor!" (November 8, 2004)

The moral of the story is, never be in a hurry to invest in a newly launched CEF. By waiting several months after the IPO, an investor can purchase the fund at a discount and avoid paying an underwriting charge. The only way to conceivably benefit from buying a CEF at the IPO is to hold onto it for a period of time that is long enough to recoup the higher price paid at the IPO.

Back to FINRA's Recent Action Against Merrill Lynch and UBS

As part of the settlement with FINRA, Merrill Lynch and UBS consented to FINRA's findings that the brokers had earned high fees through short-term trading of CEFs by recommending that their clients invest in CEFs at the IPO and sell them a few months later, usually at a loss, so that the proceeds could be invested in yet another CEF-IPO. FINRA determined that both Merrill Lynch and UBS failed to adequately supervise, monitor and detect the broker's improper activities. Without admitting any fault, Merrill Lynch and UBS agreed to pay fines of $150,000 and $100,000, respectively. They also agreed to repay a total of $5 million to victims that were identified during the investigation.