Across My Desk: Closed-end Funds
Closed-end funds provide one way for folks to invest into a basket of securities at a per share price that trades like stocks do---all day long on the major exchanges. While there's more to these investments then that singular price implies, you may also buy a closed-end fund as an IPO. But, as the following Lipper Insight Report shows, buyer beware.
What follows is the Executive Summary of the latest Lipper Fund Industry Insight Report titled, " Buying A Closed-End Fund InitialPublic Offering: Caveat Emptor!"
The study looks at the aftermarket performance of IPOs brought to market
this year. Since closed-end funds typically have no preexisting assets or
proprietary rights, there is little information asymmetry about their asset
valuation; their underlying asset is a portfolio of marketable securities
and cash. Consequently, they should exhibit little over/underpricing.
Lipper Researach findings indicate that the typical closed-end IPO is extremely unlikely
to rise sharply soon after its inception because its portfolio consists
primarily of cash. By the same token, it is also unlikely to experience
significant declines immediately following the IPO.
That said, these IPOs are more likely to experience losses in each of the first three months following its launch.
Bottom line: The typical pricing pattern of a closed-end fund IPO tends to see
little price movement during the first month. Then, Êsharper declines
in the second and third months.
As for IPO premium prices (premium prices happen when the per share price of the closed-end fund is selling for more than the basket of securities it holds) tend to disappear and turn into discounts by the end of the second and third months. Those discounts tend to widen and become persistent during the third month.
The average negative 2004 post-IPO returns amounted to 1.4% during
the first month, 5.8% during the second month, and 3.1% during the third
month. The overall accumulated three-month loss for the typical closed-end
fund was 10.6%.
My thoughts? While the IPO market may be a hot one for some equities, I'm with Lipper so look carefully before leaping into the IPO closed-end fund arena.
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