Diving Into CEFs

Comments on “The Advantages and Risks of Closed-End Funds,” by Matthew Crouse, CFA, MBA, Ph.D., in the August 2021 AAII Journal:

This overview of closed-end funds (CEFs) is well done, especially for those who have little or no experience with them. It would be great if the author could follow up with an article that dives deeper into CEF analysis and strategies.
—J.Y. from Oregon

There is a CEF from Rogers Capital Management that looks like it just invests in the S&P 500 index with a 0.6% expense ratio. Why do it?
—Paul K. from Indiana

Thanks for this article. I found it useful, mostly to clarify my thinking about this set of assets. Also, I agree with J.Y. I’d like to see deeper dives into this asset set, and some analysis with CEFs versus exchange-traded funds (ETFs) and mutual funds.
—Andrew J. from Washington, D.C.

I was looking for a section of the article focused on what can go wrong. For example, CEFs can and have dissipated their net asset value (NAV) and been liquidated or merged, like some real estate investment trust (REIT) CEFs subsequent to 2008.

Also, while I am aware that some investors may buy at a discount because they think they are getting more than $1 of assets for $1, I think it’s worth asking why people would pay a premium for a CEF. I think the premium paid reflects the dollars investors are willing to pay for reliable fund management.
—David L. from Virginia

Matthew Crouse responds:
Paul, I agree that if you are investing in an S&P 500 type of fund a CEF structure with higher expenses doesn’t make much sense. In general, a cheap index mutual fund or ETF would be better. That said, if you can buy the CEF at a deep discount it might be worth paying a slightly higher expense ratio.

David, there was an example where NAVs were dissipated: master limited partnership (MLP) funds. Liquidation sounds bad but can be favorable in that liquidations occur at NAV. Mergers are not always bad either, as the surviving fund often has a smaller discount or a premium (zero discount if an open-end fund). Although not stated explicitly, factors for why a fund might trade at a premium are the same bullet points in the section “Buying a Closed-End Fund at a Discount.” A couple of the most important reasons are a good manager and cheap leverage but sometimes there aren’t valid reasons, and a large premium is an additional source of risk.

Reducing Glide Path Risk

Comments on “Personalizing Your Glide Path to Avoid Financial Peril,” by Michael E. Drew, Ph.D., and Jason M. West, Ph.D., in the August 2021 AAII Journal:

If income sufficiency is the main criteria, the winning strategy is 100% stocks both before and during retirement. Adding cash or bonds to the mix even in retirement reduces the amount of total lifetime earnings and increases the probability of failure. This is the emotionally hard solution to investing.
—John L. from New Jersey

Don’t the return presumptions for stocks and bonds preclude this information being currently applicable to anyone within 30 years of retirement? Many of the most experienced advisers predict negative returns for the stock and bond markets for at least the next seven years. Perhaps using the historical return from 1968 for both stock and bond markets would be a better position to start from.
—Mark L. from Florida

It seems the financial industry spends a lot of time trying to fit a square peg in a round hole. Rather than glide paths and risk mitigation, a tactical asset allocation based on the current business cycle could be the best possible outcome scenario over a lifetime, at least for the average risk-averse investor. The real enemy of an investor is trying to manage risk, aka volatility, when it comes to maximizing returns. You can read “Investing at Level3” by AAII founder James Cloonan for insight.
—Michael M. from Virginia

Michael Drew and Jason West respond:
The most important question to ask in this debate is, what is the objective? For many years, we have been in the camp of saying that the key risk facing workers is retirement income uncertainty. Historically, the objective function has largely been around maximization of wealth at retirement. That has led to a range of assumptions being built in, including that there is this magical date in the future that everybody lands on. Few individuals experience a continuous working life followed by a smooth transition to retirement, and the research globally shows that maybe only about half of people get to decide their retirement date. Life gets in the way of a beautiful glide path.