Guide Closed-End Fund Pricing: Theories and Evidence (Innovations in Financial Markets and Institutions)

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Closed-End Fund Pricing: Theories and Evidence (Innovations in Financial Markets and Institutions) - Kindle edition by Seth Anderson, Jeffery A. Born.
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Closed-End Investment Companies CEICs have experienced a significant revival of interest, both as investment vehicles and as the subject of academic research, over the past decade. This academic research has focused on the nature of closed-end funds' discounts and premiums and on the share price behavior of these firms. The first book by the authors, "Closed-End Investment Companies: Issues and Answers," addresses closed-end fund academic articles published prior to This second book addresses those articles that have appeared since that time.

The authors summarize the evolution of CEICs, present the factors thought to cause CEIC shares to trade at different levels from their net asset values, provide a complete survey of the recent academic literature on this topic, and summarize the current state of research on CEICs. Read more Read less. Prime Book Box for Kids. Sponsored products related to this item What's this? Page 1 of 1 Start over Page 1 of 1.

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Jeffery A. Born - Google Scholar Citations

Then use it to make money for the rest of your life! A man of action's credo. ETFs, which allow intraday trading of shares in passive portfolios on a secondary market, grew even faster Box B. Growth in passive funds has been rapid for both equity and bond asset classes centre panel. The rising popularity of passive equity funds has displaced investment in their active counterparts, which experienced outflows over the past decade right-hand panel.

The implications of passive investing for securities markets

Net outflows from active bond funds were concentrated in and - periods of bond market turbulence. Most of the remaining passive funds specialise in commodities. Despite the rapid growth of passive bond funds, the majority of passive portfolios remain focused on equities. To some degree, this reflects the greater liquidity and exchange-traded nature of equities. In addition, constructing and tracking indices of equities is easier because they are perpetual securities, while the high correlation of interest rates may make holding broad market index bond portfolios less attractive Fender Across countries, passive funds have gained most prominence in US equities.

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Although starting from a much lower base, passive funds have gained even more traction among Japanese equity funds, supported by the Bank of Japan's ETF purchases and the Government Pension Investment Fund's increased allocation towards equities over recent years. While passive funds have made substantial inroads into the universe of investment vehicles available to end investors, their holdings as a share of total outstanding securities remain at a relatively low level due to the sizeable holdings of other non-fund investors Table 1.

Using assets managed by index tracking funds is a simple approach to measuring the extent of passive investing, but it is not without shortcomings.


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In practice, the distinction between passive and active fund strategies is fuzzy. The risk of outflows if they underperform their benchmark leads many active funds to avoid portfolios that deviate substantially from those of the market index. Cremers et al find that in many countries the share of "closet indexing" where weights of securities in equity fund portfolios are not substantially different from those of the benchmark is more or less the same as that of "explicit indexing", if not higher.

Closet indexing is also prevalent among actively managed bond funds, particularly those investing in EMEs Miyajima and Shim Furthermore, other investors, such as pension funds and insurance companies, may implement passive investment strategies in their portfolios managed in-house or through investment vehicles other than mutual funds and ETFs. The rise of "smart beta" ETFs further blurs the distinction between passive and active fund management. Rather than track traditional market value-weighted indices, smart beta ETFs implement factor-weighting index strategies such as those for value, volatility and dividend yield , the construction of which can be considered active in nature Blackrock In sum, ascertaining the true extent of passive investing is challenging.

Nonetheless, it seems clear that over recent years there has been a substantial shift towards passive portfolio management globally. The end users' choice of investment vehicle depends on not only the track record of the fund manager but also how the manager's style accords with their preferences and risk appetite. There are several general considerations for individual investors in deciding whether or not to adopt a passive investment strategy market-wide considerations are discussed further below.

From a theoretical perspective, the rationale for individual investors adopting a passive investment strategy is grounded in the notion of efficient markets. This theory holds that security prices rapidly incorporate all available information, implying that excess future returns are not predictable. Limited scope for systematic outperformance raises doubt about the rationale of incurring management fees in excess of those necessary to maintain a diversified market portfolio.

Even if one rejects the notion of market efficiency and thus the inability of managers to produce above-market returns over time , passive investing can still be considered an optimal strategy to the extent that outperformance of the market benchmark is a "zero sum game" Sharpe , Malkiel Since passive investors' average return before costs should, by construction, equal the market return, the average return across all active investors must also equal the market return. Given that active investors are attempting to beat the market, any gains for some of these investors must be offset by the losses of others.

Thus, after trading costs, the average return for active investors will be less than for passive ones. In principle, investors could earn superior returns by selecting those active funds that outperform. But identifying such funds can be difficult in practice because it requires ex ante information about the incentives and skill of a manager. Adopting a strict index-based investment strategy therefore circumvents the main asymmetric information and agency problems arising from delegating authority for investment decisions to a fund manager Vayanos and Woolley Notwithstanding the above arguments, there may still be a strong theoretical case for active management.

First, informed active managers can earn above-market returns to the extent that the investor universe also includes active but uninformed investors whose aggregate portfolio underperforms the market. Second, while the zero sum game argument holds for a constant market portfolio, in reality passive fund managers must trade albeit not frequently to manage investor inflows and outflows and because indices themselves are not static Pedersen This means that, on average, informed active investors could outperform the benchmark by taking advantage of passive managers' predictable trading patterns, such as by trading in anticipation of adjustment to index membership or ahead of initial public offerings.

Various factors have contributed to the growing investor preference for passive funds in recent years. A key one has been the better performance record of passive funds over actively managed funds. After fees and expenses, most active equity funds have failed to outperform the market benchmark in recent years Graph 2 , left-hand panel. Moreover, at least in major markets, funds that outperformed their benchmark have not done so consistently. By and large, the findings of the empirical literature accord with recent experience; after fees and expenses, the average active equity fund underperforms the market portfolio over long horizons eg Jenson , Carhart , Fama and French , Busse et al Although the literature is much less extensive, there are comparable findings of underperformance by active bond funds, on average, after adjusting for the riskiness of fund portfolios relative to the market benchmark Blake et al , Cici and Gibson The recent popularity of lower-cost passive funds has been supported by structural shifts in the financial advisory industry.

Regulators' greater focus on fee transparency has also played a role in some jurisdictions. The bulk of money flowing into passive funds over recent years has been directed to the largest fund managers, which tend to offer the lowest-cost funds.


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  8. This pattern of inflows can set in motion scale economies that help compress fees Graph 2 , right-hand panel. It also enables greater netting of inflows and outflows, as well as the negotiation of more favourable trading fees from brokers, thus reducing trading costs. Greater use of information and computational technology is another factor underlying the development of the index industry and the rise of passive investing. There has been a marked expansion in the range of indices beyond traditional broad market benchmarks, opening up investment and diversification opportunities previously inaccessible to many investors.

    Lastly, the recent period of low volatility and associated high correlations within asset classes might have reduced the rewards to active security selection. The discussion in the previous two sections provided an individual-investor perspective on the rise of passive investing.


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    The adoption of passive strategies by an increasing share of investors also has implications for security prices and issuers. Passive fund investment decisions are made at the portfolio level and not at the level of individual securities. Passive fund managers and investors naturally place emphasis on systematic or common factors affecting portfolio returns, such as expectations about monetary policy, inflation and other macroeconomic factors.

    By contrast, passive portfolio managers have scant interest in the idiosyncratic attributes of individual securities in an index. They do not devote resources to seeking out and using security-specific information relevant for valuing individual securities. In effect, they free-ride on the efforts of active investors in this regard. Hence, an increase in the share of passive portfolios might reduce the amount of information embedded in prices, and contribute to pricing inefficiency and the misallocation of capital.

    An increase in passively managed portfolios could also affect the pricing of securities through greater portfolio-wide trading in the market. Passive managers buy and sell the entire basket of index constituents in response to fund inflows and outflows. This trading pattern can induce higher co-movement in the prices of the constituents of the index. Numerous academic studies across a range of equity markets have identified co-movement, price pressures and other trading effects as securities are added to a benchmark index eg Barberis et al , Kaul et al , Claessens and Yafen Research lends support to the view that index inclusion effects reflect "non-fundamental" investor demand shocks Pruitt and Wei , Greenwood , Claessens and Yafen It should be noted, however, that these effects also create counterbalancing forces.

    At some point, greater anomalies in individual security prices would be expected to increase the gains from informed analysis and active trading, and thus spur more active investment strategies.

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    Thus, in markets that are already deep and efficient, the returns to active investors' information gathering should be relatively low and returns to scale from passive investing relatively high, all else equal. Evidence in support of this view might be found in the fact that passive funds have been able to secure a higher share of equity market capitalisation in advanced economies AEs than in EMEs Table 1.

    Going beyond the impact on the prices of individual securities, growth in passive funds might also influence the decisions and profile of security issuers.

    A general consideration is that passive investing may alter the relationship between issuers and investors. By design, passive funds invest in all securities included in the index they track. Unlike active investors, they cannot express their disagreement with the decisions of individual issuers by selling their holdings. A higher share of passive investors could therefore weaken market discipline and alter the incentives of corporate and sovereign issuers to act in the interest of investors.

    Growth of passive bond funds, specifically, might encourage leverage by borrowers. Because inclusion in bond indices is based on the market value of outstanding bonds that is, the face value of bond debt times its price , the largest issuers tend to more heavily represented in bond indices. As passive bond funds mechanically replicate the index weights in their portfolios, their growth will generate demand for the debt of the larger, and potentially more leveraged, issuers.

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    From a financial stability perspective, there is a concern that this can act procyclically and encourage aggregate leverage. The analysis presented in Box A , which is based on a major global corporate bond index, suggests that passive bond funds do indeed obtain greater exposure to firm leverage than to firm size.