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‘Open-ending’ closed-end funds
Journal
of Financial
Economics
13 (1984) 491- 507. North-Holland
‘OPEN-ENDING’
CLOSED-END
Greggory
FUNDS
A. BRAUER*
Uniuersi~ of Iowa, Iowa City. IA S2242, USA Received
September
1982, final version received June 1984
Open-ending a closed-end fund forces the price of the fund’s shares to their net asset value. Open-ending behavior is shown to correspond in predictable ways to the incentive to open-end and to potential resistance to open-ending. Moreover, closed-end fund share prices begin to generate statistically significant positive abnormal returns well in advance of the formal announcement of the open-ending. Although a small part of the total abnormal return is not entirely exhausted until after the announcement, such market price performance is broadly consistent with a semi-strong form efficient market.
1. Introduction Closed-end funds differ from open-end, or mutual, funds in that they rarely issue or redeem their own securities, whereas mutual funds stand ready to sell or repurchase their shares at net asset value per share (value of securities held less liabilities all divided by number of shares outstanding). Consequently, while a mutual fund’s shares trade at their net asset value, the price of a closed-end fund’s shares need not equal their net asset value. The resulting discounts and premiums on closed-end funds have attracted the attention of several authors.’ Malkiel (1977) summarized many of the attempts to explain discounts and premiums and found three useful variables: the tax liability associated with unrealized capital gains, fund policy with respect to the distribution of capital gains, and fund holdings of relatively illiquid letter stocks and foreign securities. The effects of these three considerations, however, ‘. _. explain only a small part of the discounts that exist’ [Malkiel (1977, p. 857)]. Malkiel (1977, p. 858) concluded that the remaining unexplained discount is ‘ . . . an example of a market imperfection in the valuation of capital *I would like to thank Tom Cook, Wayne Ferson, Forrest Nelson, Mike RozeK, Gerry Salamon, Clifford Smith, and the referees for this Journal, Rex Thompson and Marc Reinganum, for their valuable comments. All remaining errors are the author’s sole responsibility. This project was supported in part by a research fellowship grant from the University of Iowa. ‘See, for example, Pratt (1966), Boudreaux (1973), Roenfeldt and Tuttle (1973), Walters (1973), Zweig (1973), Sharpe and Sosin (1974), Hanna (1977), Ma&e1 (1977), Mendelson (1978). Thompson (1978), Richards, Fraser and Groth (1979) and Leonard and Nobel (1981).
0304-405X/84/S3.00@198;1,
Elsevier Science Publishers
B.V. (North-Holland)
492
GA. Brauer, ‘Open-ending’ closed-end fur&
assets’. Thompson (1978) drew a similar inference after an extensive investigation of the returns to portfolio strategies based on closed-end fund discounts and premiums and evaluated against capital asset pricing model specifications of risk-adjusted return. His finding that ‘. . . discounted closed-end fund shares tend to outperform the market, adjusted for risk.. .’ led him to conclude that ‘ . . . it is not possible to identify the extent to which the results reflect capital market information inefficiency as opposed to a breakdown in the applicability of two-parameter asset pricing theory’ [Thompson (1978, p. 182)]. This paper investigates the rationality and informational efficiency of the market for closed-end fund shares by examining ‘open-ending’ behavior. The term open-ending will be used to refer to a class of events designed to force the market price of a closed-end fund’s shares to net asset value. The effects of the incentive to open-end and potential resistance to open-ending will be investigated and the speed with which the share price reacts to open-ending information will be evaluated. Since discounts and premiums have not been fully explained, this exercise is analogous to Stigler’s (1966) discussion of Christmas clubs that pay no interest. Although certain aspects of observed behavior may be incompletely understood (the existence of Christmas clubs or closed-end fund discounts and premiums), useful economic theories still have the power to predict other aspects of behavior (changes in Christmas club balances in response to changes in interest rates or price reaction to open-ending). The remainder of the paper is organized as follows. Section 2 will describe open-ending in more detail and investigate the incentive to open-end and a potential source of resistance to open-ending. Section 3 will examine the share price reaction to open-ending information. Section 4 concludes the paper. 2. Open-ending:
Evidence on why some funds do and other funds do not
Open-ending events are usually initiated by shareholders hoping to eliminate the discount from net asset value at which most closed-end funds sell. At least three organizational changes will force a share’s price to its net asset value. The most obvious option is simply to change the form of the fund from closed-end to mutual. The same result can also be achieved by merging a closed-end fund with a mutual fund. Liquidating the fund’s assets and distributing the proceeds also increases the value of the claim represented by fund shares.2 Table 1 presents a list of closed-end funds that have been open-ended since 1960. Advance Investors, Boston Personal Property Trust, Carriers & General,
‘There are, of course, transaction costs involved that will prevent the share price from going to exactly its net asset value. The case of Consolidated Investment Trust is an example. The trust announced in 1967 that it would liquidate, but at the end of 1981 about half the shares outstanding in 1966 were still outstanding and selling at a discount of two to three percent. The fund stands ready to redeem outstanding shares at net asset value, but has the option of making the redemption in cash or securities. The transaction costs of liquidating the securities the fund might distribute presumably accounts for the continuing discount.
493
G.A. Bmuer, ‘Open-ending’ closed-end funds Table 1 Closed-end
funds that have been open-ended
Fund name M.A. Hanna Boston Persona1 Property Trust Consolidated Investment Trust Surveyor Dominick International Holdings Gtiesedick Advance Investors American Utility Shares Keystone OTC Fund United Corporation National Aviation&Technology Carriers & Genera1 Chase Convertible Fund of Boston
since 1960.
Fund investment policy A
Month and year of official announcement of impending open-ending
ND&S DIV DIV DIV DIV DIV DIV DIV ND&S ND&S ND&S ND&S DIV SS
lo/65 l/66 3/67 9/73 IO/74 8/75 4/76 7/76 11/77 12/77 l/78 7/78 5/81 11/81
a ND&S indicates non-diversified and specialized funds, DIV indicates diversified funds. and SS indicates senior security funds. Classifications from Inoesttnent Compunies by Arthur Weisenberger.
and National Aviation & Technology were all straightforward reorganizations from closed-end funds to mutual funds. Chase Convertible Fund of Boston was reorganized into a series of the Phoenix-Chase Series Fund. The Keystone OTC Fund was combined with the Keystone Apollo Fund to form the mutual Polaris Fund. American Utility Shares was merged into the Lord Abbet Fund, Dominick was merged into Putman Investors Fund, International Holdings was merged into Cheapside Dollar Fund, and Surveyor was merged into Eberstadt Fund. All the latter partners were mutual funds. United Corporation was in part merged into D.H. Baldwin Company and in part liquidated. Consolidated Investment Trust, Griesedick, and M.A. Hanna were liquidated. The information dates cited in the table are the earliest months in which an apparently irreversible decision to open-end was made and announced. They range from the same month in which the open-ending occurred to several months in advance of the actual effective data of the open-ending. 2.1. The incentive
to open-end
The obvious incentive for open-ending is the return associated with eliminating the discount.3 The premium, P, on a closed-end fund is conventionally ‘In fact, Benl’min Graham is reputed to have said, in reference to closed-end funds: ‘The price discount of these companies may be viewed as an expensive moment erected to the inertia and stupidity of stockholders. It has cost the owners of these businesses countless millions of dollars, yet it has been totally unnecessary. It could have been terminated at any time by the mere passing of a resolution at a stockholder’s meeting’ (Hetzfeld (1980, p. 181)].
494
calculated
G.A. Brauer, ‘Open-ending’closed-endfunds
as P=(Price-NAV)/NAV,
(1)
where NA V is the net asset value and a discount is, of course, negative premium. The rate of return to shareholders, R, from forcing a fund’s price to NAV may be defined as R = ( NA V - Price)/Price,
simply a costlessly
(2)
or, in terms of the fund’s premium, R=
-P/(l+P).
(3)
A testable hypothesis about the incentive to open-end consequently is that the closed-end funds which open-end have a smaller premium than the closed-end funds which do not open-end, ceteris paribus. Two issues are relevant to the test of this hypothesis. First, since closed-end funds voluntarily restrict the compositions of their portfolios, they must be exploiting some capital market imperfection to an end that their managers feel will outweigh the investment inefficieltcy associated with not holding a more well diversified portfolio. The same imperfection might well lead to an incentive to open-end that is conditional upon the type of investment restrictions undertaken. Second, since effecting an open-ending takes time, the relevant point for evaluating the strength of the incentive to instigate open-ending is in advance of the actual event. fund one year before the Let POE denote the premium on an open-ended open-ending. Let FT denote the average premium on matching closed-end funds (i.e., funds with the same type of investment policy at the same time). for the The average POE, FOE, is an estimate of the true averag~premium population of open-ended funds, aOE. The average Fr, P,, is an estimate of the true average premium on the population of matching funds which were not open-ended, (Ye. Formally then, the first set of testable hypotheses is Hh : aOE = aT
versus
Hi : aOE -c a+.
These hypotheses can be evaluated using a variance-corrected paired comparison of POE and Fr. values.4 Note that the specificity of the alternative hypothesis dictates a one-tailed test. 4Since 7, is an average, its variance is smaller than the variance of POE and a correction to the standard paired r-test is required. The difference metric is do, = (P,, - (l/F)E/F=, P,), where there are F matching funds. Assuming the premiums are independently distributed, the variance of d,, is u2 = (I& + (l/F*)~&,u_). where c& is the variance of P and e* is the variance of the f th matching premium. If boa = e,= e for all OE and f values, zj simpljfes to ~‘(1 + l/F). This can be incorporated into the test ,by redefining the difference metric as d& = d&C, where the correction factor is c = (1 + l/F)?. This corrected difference was used because the choice of one of the F possible matches would have been arbitrary.
GA. Brauer, ‘Open-ending’closed-endfunds
495
Table 2 presents the data and test for the first pair of hypotheses. Data were gathered from The Wall Street Journal ‘Closed-End Fund’ and ‘Publicly Traded Fund’ sections (except as noted) for one year in advance of the announcement date cited in table 1. The average shareholder return from costlessly open-ending the fourteen funds was 30.9%. The average return that could have been earned by open-ending all of the same types of funds at the same respective times would have been 19.3%. The 7.4% larger average discount on the funds that were, in fact, open-ended is consistent with Ha and significant at the 0.006 level. In other words, while there is on average an incentive to open-end all closed-end funds, the incentive is statistically significantly greater for the funds which are actually open-ended.
Table 2 A variance-corrected paired comparison test of the hypothesis open-ended have on average the same premium as similar open-ended.
Open-ended
fund
M.A. Hannab Boston Pers. Plop. Trust Consolidated Invest. Trust Surveyor Dominick International Holdings Griesedickb Advance Investors American Utility Shares Keystone OTC United Corporation National Aviation & Tech. Carriers & Generalb Chase Convertible Fund Average
Premium measurement datea (month/year) 12/63 6/65 2/66 g/72 9/73 l/74 12/74 6/75 lo/76 11/76 12/76 3/77 12/79 lo/go
premium Average premium
that closed-end funds closed-end funds that
Open-ended fund premium (in percent)
Premium information similar funds Average premium (in percent)
- 20.0 - 26.4 - 18.4 ~ 25.9 -26.1 - 21.4 - 38.0 ~ 27.0 1 20.3 ~ 27.7 - 12.9 - 32.3 - 15.1 - 19.1
~ 23.3 - 10.1 ~ 10.4 - 15.4 - 17.7 - 17.9 ~ 22.1 - 22.4 - 22.3 - 12.3 - 23.1 -21.4 - 14.7 6.1
- 23.6
~ 16.2
difference
that are are not
for
Number of funds ___11’ 20d 24d 34d 13’ 14e 13’ 13’ 18s 16g 12’ 189 14’ 16g
= ~ 7.48
r-score = - 2.96 Significance
levelh = 0.006
“Premium measured at the end of the month one year before open-ending announcement. bData taken from Inuestmenr Compumes by Weisenberger because more timely information was not available in The Wull Sweet Journul. “‘Non-diversified’ funds, dAll funds; report did not catagorize funds by type. e‘Diversitied common stock’ funds. “Diversified’ funds. @Specialized equity and convertible’ funds. hTo reject the null hypothesis of equal premiums in favor of the alternattve hypothesis that the open-ended fund average is less.
496
2.2. Resistance
G.A. Brauer, ‘Open-ending’ closed-endfunds
to open-ending
If open-ending funds selling at a discount is profitable for shareholders (even though not uniformly so), there must be some reason why every closed-end fund is not immediately reorganized when its share price drops below its net asset value. A possible counteracting effect derives from the nature of the owner-agent relationship between shareholders and managers. Simply stated, open-ending threatens what Jensen and Meckling (1976) would call a fund manager’s ‘wealth and non-pecuniary benefits’. In the absence of golden parachutes activated by open-ending, managers would obviously resist liquidation. Similarly, merger threatens management wealth and perquisities. However, simple conversion to mutual fund status would be resisted only if managers of closed-end funds can extract more ‘wealth and non-pecuniary benefits’ that can managers of mutual funds. In order to determine if the agency relationship does give rise to open-ending resistance, two additional hypotheses must be investigated. Is a measure of management wealth and perquisites less for closed-end funds that are open-ended than for closed-end funds that are not open-ended, ceteris paribus? Is the measure greater for all closed-end funds than for all mutual funds, ceteris paribus? A fund’s expense ratio as reported by Weisenberger’s annual Investment Companies appears to be a reasonable proxy for the portion of its manager’s ‘wealth and non-pecuniary benefits’ produced by the fund. Relative to the expenses of investment funds Weisenberger (1982, p. 16) says: ‘All investment companies have operating expenses. Normally, the management fee is the largest part of the total. . . . this fee covers the salaries of fund officers and other personnel, as well as the cost of office space and facilities, in addition to the payment of portfolio management. . . . Brokerage costs are considered capital items, rather than fund expenses.. . .’ Further, any taxes paid are not included in the calculation of reported expenses. A fund’s expense ratio is its total expenses divided by its total net asset value. Since expenses obviously depend on fund size, expense ratios are a more appropriate measure of relative resistance than expenses in dollars. Also -in the interests of the ceteris paribus condition, a fund’s expense ratio should be compared to the average ratio for funds with similar investment restrictions. To formalize the hypothesis that open-ended closed-end funds reported smaller expense ratios than similar funds that were not open-ended, let ER.. denote the last reported expense ratio for an open-ended fund. Let m, denote the average expense ratio for closed-end funds with the same type of investment policy. In order to hold the effects of general market conditions constant, and its matching ER, should be measured over the same period. The E&E is an estimate of the true average expense ratio for the average ER oE, ?%,,, is an estimate of population of open-ended funds, yOE. The average ER,,E,,
GA. Brauer, ‘Open-ending’ closed-end funds
497
the true average expense ratio for the population of funds with the same type of investment policies at the same time as the open-ended funds, yr. Formally then, the second set of testable hypotheses is Hi:
Y~E = -tr
Hi : yOE -c yr.
versus
These hypotheses can be evaluated using ERO. and ER, in a variance-corrected paired comparison. The specificity of the alternative hypothesis again dictates a one-tailed test. Table 3 presents the data and test for the second pair of hypotheses. Data were gathered from the ‘Statistical Survey of Closed-End Funds’ section of Weisenberger’s Investment Companies for the last complete year preceding each open-ending announcement. The 0.22% smaller average expense ratio for the funds that were, in fact, open-ended is consistent with Hf, and significant at the 0.025 level. In other words, if the expense ratio is a reasonable proxy for management resistance to open-ending, the resistance is on average statistically significantly less for the funds which are actually open-ended. Table 3 A variance-corrected paired comparison test of the hypothesis that closed-end funds have on average the same expense ratio as similar closed-end funds that are not open-ended
Open-ended
fund
Open-ended fund expense ratio (in percent)
Average expense ratio (in percent)
Number of funds
1964 1965 1966 1972 1973 1974 1974 1975 1976 1976 1976 1977 1980 1980
0.21 0.18 0.13 0.80 0.83 0.72 0.57 1.17 1.04 1.29 0.82 0.97 1.24 0.90
0.x9 0.52 0.57 0.58 0.59 0.81 0.81 0.88 1.75 1.75 0.74 1.48 0.94 1.65
9” 20b 20h 14h 13h 14b 14a 12h 19s 19’ 6’ 17’ 14h loc
M.A. Hanna Boston Pers. Prop. Trust Consolidated Invest. Trust Surveyor Dominick International Holdings Griesedick Advance Investors American Utility Shares Keystone OTC United Corporation National Aviation & Tech. Carriers & General Chase Convertible Fund Average
Expense ratio information for similar funds
Last reported year before the open-ending announcement
expense ratio
0.78 Average expense ratio difference
1.00 = ~ 0.22%
t-score = 2.12 Significance “ Non-diversified’ funds. b‘Diversitied’ funds. “Specialized’ funds. ‘TO reject the null hypothesis open-ended fund average is less.
of equal
ratios
leveld = 0.025
in favor of the alternative
hypothesis
that the
GA. Bmuer, ‘Open-ending’ closed-end funds
498
Herzfeld (1980) catalogues many of the arguments against open-ending made by closed-end fund managers. An interesting artifact of his discussion is the identification of the following five open-endings as having been accomplished without significant management obstruction: M.A. Hanna, Boston Personal Property Trust, Surveyor, Griesedick, and Keystone OTC. Moreover, the following five open-endings apparently were achieved over the significant objections of fund directors: Dominick, International Holdings, Advance Investors, American Utility Shares, and National Aviation & Technology. The remaining four funds are not classified by managerial resistance. If expense ratio is a reasonable proxy for managerial resistance, then the average expense ratio of the low-resistance group should be less than the average for the high-resistance group. This is precisely the case. The low-resistance group had an average expense ratio in the year preceding announcement of 0.61% versus an average for the high-resistance group of 0.95%. These are comparisons of raw ratios, however. When matching is used to hold the effects of different investment policies and different general economic conditions constant, the low-resistance group had an average expense ratio 0.30% less than their matching funds, while the high-resistance group had an average expense ratio only 0.16% less than their matching funds. Although groups of five are too small to demonstrate statistical significance, the differences for the low- and high-resistance subsamples are consistent with the expense ratio performing as a reasonable proxy for degree of management resistance. To formalize the hypothesis that on average closed-end fund expense ratios are larger than expense ratios for comparable mutual funds, let ERc. denote the expense ratio on any closed-end fund from 1965 through 1981 (the time period during which open-endings occurred), and let ER, denote the expense ratio on a matching mutual fund. Since trades of closed-end fund shares take place in a transactionally costly secondary market, closed-end funds should be matched only with load type mutual funds. As before, both funds should have the same investment restrictions and both ratios should be for the same year. is an estimate of the true average expense ratio for The average ER =-, @.,, the population of closed-end funds, yCE. The average ER,, ER,, is an estimate of the true average expense ratio for the population of mutual funds, y,,,,. Formally, a third set of hypotheses is H,~:Y~E=YM
versus
Hi : yCE > yw.
These hypotheses can be evaluated using ER,, comparison.s Again, a one-tailed test is indicated.
and
ER,
in a paired
5To break the ties when more than one mutual fund match was found on the basis of load, investment policy, and time period, the mutual fund of most nearly the same size (by total net asset value) was selected. This method of handling ties is an alternative to the variance-correction approach discussed in footnote 4. While this method collects less information per match (although fund size is not an entirely arbitrary tie-breaker), the much larger sample size here makes for a powerful test.
G.A. Brauer, ‘Open-ending’ciosed-end funds
499
Table 4 presents the data and test for the third set of hypotheses. The data were gathered from Weisenberger’s Investment Companies for each of the seventeen years covered by table 1. The closed-end fund expense ratios are reported in the ‘Statistical Survey of Closed-End Funds’ section and the matching mutual fund ratios were selected from the ‘Statistical Survey of Mutual Funds’ or ‘Mutual Funds Panorama’ sections. While the average expense ratio difference was always in the predicted direction, it was not always statistically significant at conventional levels. Over all 826 pairs, however, the 0.21% larger average ratio for closed-end funds is consistent with Hi and extremely significant. In other words, on average closed-end fund managers face a statistically significant loss in ‘wealth and non-pecuniary benefits’ if their funds are reorganized into mutual funds.
2.3. Additional
evidence
The evidence questions. First,
presented to this point suggests two additional interesting can relative premiums and expense ratios be used simulta-
Table 4 A paired
Year(s) 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1965-1981
comparison
test of the hypothesis that closed-end funds expense ratios as similar mutual funds.
have on average
the same
Average of closed-end fund expense ratio minus mutual fund expense ratio (in percent)
t-score
42 42 41 37 39 39 36 32 51 67 66 61 56 54 57 55 51
0.0929 0.0612 0.0527 0.0549 0.1167 0.0664 0.1939 0.1322 0.2525 0.3199 0.2895 0.3236 0.3070 0.1863 0.2632 0.2744 0.2541
0.99 0.76 0.61 0.62 1.13 0.82 2.09 1.29 2.67 2.92 2.92 2.50 2.90 2.02 2.35 2.01 2.83
0.1631 0.2266 0.2741 0.2706 0.1322 0.2093 0.0218 0.1035 0.0051 0.0024 0.0024 0.0075 0.0027 0.0240 0.0112 0.0249 0.0034
826
0.2088
8.05
i 0.0001
Number of closed-end fund and mutual fund pairs”
Significance levelb
‘Number of closed-end funds for which a ‘meaningful’ expense ratio was reported in Weisenberger’s InvestmentCornponies. bTo reject the null hypothesis of no difference in expense ratios in favor of the alternative hypothesis that closed-end fund expense ratios are greater.
G.A. Bmuer, ‘Open-ending’
500
ciosed-end funds
neously to form a predictive model of open-endings? Second, while cross-sectional comparisons have been conducted in the interests of holding the effects of general market conditions constant, are the premiums and expense ratios immediately before the open-ending smaller than their own historical averages? With respect to the first question, a reasonable model of open-ending can be constructed using relative premiums and expense ratios. Let y be a binary variable for fund i taking on the value one for an open-ended fund or the value zero for a fund which remains closed-end. Let Pi’ = P, - PT where Pi is the premium on closed-end fund i. Let ER: = ER, - m, where ER, is the expense ratio for closed-end fund i. The model is t = a, + a,P,‘+ a,ER;
+ Z,,
where a,, a,, and a2 are coefficients to be estimated, and ,Zi is an error term. The estimated values of a, and a2 should be significantly negative according to the incentive and resistance hypotheses. Binary dependent variables are known to cause standard t-test statistics not to be distributed according to the r-distribution and to cause coefficient variance estimates to be biased. However, Mosteller and Tukey (1977) have demonstrated a convenient hypothesis-testing technique (called jackknifing) for binary dependent variable regression coefficients. A random sample of 14 closed-end funds was drawn from the 826 observations used to test hypothesis Hi and combined with the 14 open-endings to create a set of 28 observations over which the coefficients for eq. (4) were estimated and tested using jackknifing.6 The estimated coefficient values were 0.420 for a,, - 0.012 for a,, and -0.368 for a2. The estimates of a, and a2 were significantly different from zero at the 0.025 and 0.050 levels, respectively. These results are consistent with the incentive and resistance hypotheses. In place of the inappropriate F-test, jackknifing provides an assessment of the asymptotic ability of the model to sort out open-ended from non-open-ended funds. Only about 57% of the funds would be correctly classified if (4) could be estimated over an infinite number of observations. While cross-sectional differences in premiums and expense ratios are useful in predicting open-endings, they clearly do not capture all relevant considerations. Moving to the second question, recall that the goal of cross-sectional matching was to hold the effects of general economic and market conditions constant. Matching pre-open-ending premiums and expense ratios with their respective historical averages may result in weaker tests of the incentive and resistance hypotheses. As a descriptive exercise, however, a time-series comparison yields some additional insight. ‘Details
about
this procedure
are available
from the author.
GA. Brauer, ‘Open-ending’ closed-end funds
501
All the premiums that could be found in either The Wall Street Journal or Investment Companies for the two years immediately preceding the measurement dates in table 2 were collected for each of the open-ended funds. The fund-by-fund averages of these historical premiums were matched with their respective pre-open-ending premiums as reported in table 2 and a variancecorrected paired comparison test was performed. The historical average premium for the 14 funds was -22.2%, compared to the average pre-open-ending premium of - 23.6%. Consequently, the open-ended funds were, indeed, selling at a larger than (time-series) average discount one year before the announcement. This observation is consistent with the incentive hypothesis. The t-score for the paired comparison test is, however, only -0.97 and not significant at conventional levels. All the expense ratios reported in Investment Companies for the post World War II years preceding the measurement dates in table 3 were collected for each of the open-ended funds. The fund-by-fund averages of these historical ratios were matched with their respective pre-open-ending ratios as reported in table 3, and a variance-corrected paired comparison test was performed. The historical average ratio for the 14 funds was 0.66% compared to the average pre-open-ending ratio of 0.78%. Consequently, the expense ratios of open-ended funds in the last year before the announcement were, in fact, larger than their historical averages. This observation is apparently precisely contrary to the resistance hypothesis. Moreover, the t-score from the paired comparison test is 2.55 and significant at the 0.014 level. The jackknifing tests of the simultaneous effects model, eq. (4) concluded that, while cross-sectional relative premium and expense ratio information was useful in ways consistent with the incentive and resistance hypotheses, additional considerations obviously were also relevant. A case can be made that a significant increase in the expense ratio represents such an additional consideration. Because the reported net asset value does not include the capitalized value of future expenses, it overstates the true net asset value (based on future cash inflows from assets owned and future cash outflows to asset managers). This net asset value overstatement implies that the reported discount overstates the true discount. The incentive to open-end is presumably related to the size of the true discount.’ An increase in the expense ratio will cause the true discount to go up by more than the increment in the reported discount if the higher level of expenses is expected to be maintained into the future. As a result, an increase in the expense ratio may be a signal to shareholders to increase open-ending pressure. Expense ratios hence provide information about the relative resistance hypothesis in cross-sectional comparisons while also providing information about the incentive hypothesis in time-series compari‘Tests of the incentive hypothesis have consequently been using an instrumental using the observable reported discount instead of the unobservable true discount.
variable
by
G.A. Brauer, ‘Open-ending’
502
closed-end funds
sons. Empirically, the pre-open-ending increase in expense ratios was significant and associated with an insignificant increase in reported discounts but an obviously significant increase in open-ending pressure.
3. Open-ending: The market reaction Having seen that the open-ending evidence is consistent with rational behavior by fund owners and managers, consider now the capital market reaction to open-ending. Specifically, if the market for closed-end fund shares is at least semi-strong form efficient, then the shares of funds which are open-ended should begin to exhibit abnormal positive returns immediately upon the public announcement that the fund will be open-ended.’ Since some information about the prospects for an open-ending will very probably have leaked into the market in advance of the official announcement. abnormal return performance might even be observed over the pre-formal-announcement period. However, the statistical hypotheses to be tested in this section will be formally stated as9 Hi: No average abnormal return are open-ended immediately the pending open-ending. versus
on the shares of closed-end funds which after the first official announcement of
Hi: Positive average abnormal return on the shares of closed-end funds which are open-ended immediately after the first official announcement of the pending open-ending.
3. I. Methodology The technique used to measure abnormal returns was developed by Fama, Fisher, Jensen and Roll (1969). The statistical significance of the abnormal returns is determined using the procedure developed by Jaffe (1974) and Mandelker (1974).
‘Thompson (1978) showed that the equally-weighted average return on closed-end funds’ typically discounted prices is not significantly different from the risk-adjusted return predicted by an equilibrium model of asset pricing. (See his table 4.) Since the event of open-ending forces the discounted price to net asset value, it must on average generate abnormal returns. ‘Thompson (1978) also showed that portfolios constructed using weights based on discount information earn abnormal returns (even though on equally weighted average, closed-end funds provide a normal risk-adjusted return). Since open-ending is related to discount, in order to ensure that the market efficiency hypotheses tests do not simply replicate the abnormal return performance documented by Thompson, the hypotheses could more accurately be stated in terms of ‘average abnormal returns in excess of those found by Thompson’. As will be seen below, the abnormal returns associated with open-ending are very much huger than those reported by Thompson.
GA. Brauer, ‘Open-ending’ closed-end junh
Let some model of the process normally fund i in period t be represented as
generating
503
the return
on shares of
k, =f(X,) + z,,,
(5)
where ii,, is the normal return to fund i in period t based upon some set of return determinants in r denoted X, (which does not include information about open-ending) and I,, is a random error term unique to fund i in period t. The variable Z,, is usually assumed to have a zero expected value, constant variance through time, no serial correlation, and no correlation with any part of X,. The ex-post abnormal return for fund i in period t may be defined as
(6)
AR,, = R,, -f(4),
where R,, is the observed return on fund i in period t. To reduce the impact of random measurement errors of X,, the Fama-Fisher-Jensen-Roll method averages the abnormal returns across funds for each t relative to the information event as follows:
AR, = 5 ARir/N.
(7)
r=l
where N is the number of funds. These average lated over the period from k to t by
CAR,=
i
abnormal
returns
AR,.
are cumu-
(8)
/=k
The Jaffe-Mandelker test forms equally weighted portfolios in calendar-time which are consistent with the event-time frames used to generate the average and cumulative abnormal returns. By forming a calendar-time portfolio, the contemporaneous correlations between security returns are reflected in the portfolio performance and the excess portfolio returns can be treated as independent. The standard deviation of past excess portfolio returns can then be used to standardize the current excess return and form a test statistic. For month m in calendar-time, when a strategy calls for the ownership of at least one stock, the abnormal return on the portfolio held is denoted PAR,,,. The variability of this abnormal return is estimated by the following standard deviation:
PAR,-
$
“i’ q=m-60
PAR,
.
(9)
GA. Brauer, ‘Open-ending’closed-endfunds
504
The standard deviation estimate return in period m as follows:
is used to standardize
the abnormal
portfolio
PARS, = PAR,/s,. The standardized are averaged by
(10)
abnormal
portfolio
returns
for a given strategy
through
time
675 PAR’=
(l/n)
c cm0
=
(11)
PAR”,,,, 454
where the time index cmo is denominated in months as defined by the Center for Research in Security Prices at the University of Chicago (CRSP). CRSPmonth 454 is 24 months before the information date for M.A. Hanna, and CRSP-month 675 is the last CRSP-month for which data is available for Chase Convertible Fund of Boston. In eq. (11) n is the number of months in which a portfolio consisting of at least one security was held. The test statistic to determine the significance of the average standardized monthly abnormal return to a portfolio strategy is tp =EJZ/(l/n:), and is distributed
according
(12) to Student’s
t.
Monthly information on shares outstanding, share prices, and dividends were collected for the open-ended funds from the CRSP monthly tape, from Weisenberger’s Investment Companies, from The Wall Street Journal, and from the New York Times.
3.2. Results The market model holds that the return to security i in period determined by a process that can be represented as follows: A,, = b,i + bi,Rmt + P,,,
t is
(13)
where R,, is the return on some widely-based market index in period t and b,, and b,; are parameters unique to security i. lo Reserve the t subscript for time
“Ingersoll (1976) has used an alternative model, the option pricing model, to investigate dual purpose funds, Dual purpose funds are like closed-end funds except that they have an exphcit maturity date. Ingersoll concludes that regular closed-end funds will sell at a discount whenever a fund must pay management fees and ‘ fund shares are not redeemable at asset value’. His second condition may be interpreted as open-ending being transactionally costly. Malkiel’s (1977) investigation of the impact of management fees found their effect to be too small to explain the size of observed discounts. He did not, however, address the cost of open-ending.
GA. Brauer, ‘Open-ending’ closed-end funa!s
505
relative to the information event. To allow for potential instability in the estimates of b,, and b,;, ordinary least squares regressions were used to estimate ba,, and but for values of t ranging from - 24 to - 1 by estimating
k” = bo,,+ blr*Rmv + P,“,
(14)
using values of u from t - 60 to t - 1 and the CRSP value-weighted total return (dividends plus price appreciation) market index. Abnormal returns were then
Table 5 presents the average abnormal returns and two cumulative abnormal returns (from k = - 12 and from k = + 1) that resulted from using the market
Table 5 Abnormal monthly returns (in percent) surrounding the announcement of an open-ending using the market model as the normal return generator (14 open-endings from 1960 through 1981). Event time - 12 -11 - 10 - 9 - 8 - 7 ~ 6 - 5 - 4 ~ 3 - 2 - 1 0 + 1 + 2 + 3 + 4 + 5 + 6 + I + 8 + 9 + 10 +11 + 12
Average abnormal return”
Cumulative abormal return’
- 0.1069 3.1832* - 0.4664 2.2061 ~ 0.8522 2.9413* -0.1192 3.9296** - 0.6934 2.1490 1.4693 3.4124** 5.1755** 4.1050* 1.6118 3.5411* - 2.3653 1.3121 - 1.7981 2.7653 ~ 0.0557 - 0.8753 -0.1918 -0.3118 - 1.7175
-0.1069 3.0763 2.6099 4.8166 5.6688 X.6101* 8.4909* 12.4205** 11.7271** 13.8761** 15.3454** 18.7578*** 23.9333*** 28.0383** 29.6501* 33.1912* 30.8259 32.1380 30.3399 33.1052 33.0495 32.1742 31.9824 31.6706 29.9531
Cumulative abnormal return”
4.1050s 5.7168 9.2579* 6.8926 8.2047 6.4066 9.1719 9.1162 8.2409 8.0491 7.1373 6.0198
a* indicates significant at the 10% level, ** indicates significant at the 5% level, and *** indicates significant at the 1% level to reject the null hypothesis that the standardized counterparts are zero in favor of the alternative hypothesis that they are positive.
506
GA. Brauer, ‘Open-ending’ closed-end funds
model to generate normal returns. l1 The table has a number of interesting features. First, the 25 average abnormal returns ranged from -2.4% to 5.2%, with 14 positive and 11 negative. Notice that the largest average abnormal return was in the announcement month. Second, when those average returns are cumulated starting 12 months before the information event date, a series of positive cumulative returns was built up over the first 14 months, and then the series became generally stable over the last 11 months, accumulating a positive abnormal return of nearly 30% over the two years. Even though the unstandardized CAR’s remained above the month zero level through month +12, their significance fell dramatically due to the number of funds dropping out of the sample soon after the announcement date. In fact, only three funds survived past event-month three. Finally, when the average abnormal returns were cumulated over just the 12 months following the information event, a 6% abnormal return resulted. Although the CAR’s were all positive, the last conceivably significant standardized value was in month three. These patterns are consistent with cross-sectionally large discounts on the funds during the second year before they are open-ended (approximately 24% on the funds which are open-ended compared with an average discount on all closed-end funds of about 16%). In the one year before the information event used in this study, news of the potential, and as yet uncertain, event appears to have been leaking into the market causing the discounts to narrow and the returns to begin exhibiting abnormal positive performance. While most of the abnormal performance was exhausted by month zero, a strategy of buying shares upon the announcement and holding them for three months would have been rewarded with abnormal returns. l2 These returns could be interpreted as resulting from the resolution of any lingering uncertainty about the openending even after the fund’s official announcement. Strictly speaking, however, Hi can be rejected in favor of Hi. 4. Conclusion Three main results about closed-end funds have been demonstrated. First, open-ending activity accords well with the shareholder incentive to open-end provided by share price discounts from net asset value. Second, open-ending activity also corresponds to managerial resistance to the loss of ‘wealth and “A check type. Also, addition to reported in
of returns from I = - 24 through I = - 13 showed no abnormal performance of any a multi-index model using an orthogonahzed closed-end fund industry index (in a market index) was investigated. The results were not significantly different than those table 5.
‘*Note that the 9.26% CAR from event month + 1 through + 3 is gross of transaction costs. TO remain statistically significantly different from zero, the CAR net of transaction costs would have to have been greater than about 7.00%. Transaction costs in the neighborhood of 2.26% may not be beyond reason.
GA. Brauer, ‘Open-ending’closed-endfunds
507
non-pecuniary benefits’ caused by open-ending. Third, while abnormal returns were possible from buying the shares of open-ended funds in the announcement month and holding them for three months (to the extent that funds remained closed-end for as long as three months after the announcement), most of the abnormal return associated with open-ending was exhausted by the end of the announcement month. With respect to open-ending, the behavior of closed-end fund participants is generally rational and the market for closed-end fund shares is generally efficient. If these traits are characteristic of closed-end funds in general, then the persistent discounts at which most funds sell must have a rational explanation in an efficient market. In other words, claims that the unexplained (and majority) portion of closed-end fund discounts are due to an ‘imperfect’ or inefficient market now seem less warranted. References Boudreaux, K., 1973, Discounts and premiums on closed-end mutual funds: A study in valuation, Journal of Finance 28. 515-522. Bricklev, J. and J. Schallheim, 1983, Lifting the lid on closed-end investment companies: A case of abnormal returns, Working paper (University of Utah, Salt Lake City. UT). _ Fama. E.. L. Fisher. M. Jensen and R. Roll, 1969. The adtustment of stock urices to new information, International Economic Review 10, 1-21. Hanna, M., 1977, An investor expectations price predictive model using closed-end fund premiums: Comment, Journal of Finance 32, 1368-1371. Herzfeld, T., 1980, The investor’s guide to closed-end funds (McGraw-Hill, New York). Ingersoll, J., 1976, A theoretical and empirical investigation of the dual purpose funds, Journal of Financial Economics 3, 83-123. Jaffe, J., 1974, Special information and insider trading, Journal of Business 47, 410-428. Jensen, M. and W. Meckling, 1976, Theory of the firm: Managerial behavior. agency costs and ownership structure, Journal of Financial Economics 3. 305-360. Leonard, D. and N. Nobel, 1981, Estimation of time-varymg systematic risk and investment performance: Closed-end investment companies, Journal of Financial Research 4. 1099120. Malkiel, B., 1977, The valuation of closed-end investment company shares. Journal of Finance 32. 847-859. Mandelker, G., 1974, Risk and return: The case of merging firms, Journal of Financial Economics 1, 303-335. Mendelson, M., 1978, Closed-end fund discounts tevisited, Financial Review. Spring. 48-72. Mosteller, F. and J. Tukey, 1977, Data analysis and regression (Addison-Wesley, Reading, MA). Pratt, E., 1966, Myths associated with closed-end investment company discounts, Financial Analysts Journal, July-Aug., 79-82. Richards, R., D. Fraser and J. Groth. 1979, Premiums, discounts, and the volatility of closed-end mutual funds, Financial Review. Fall, 26-33. Roenfeldt, R. and D. ‘Tuttle, 1973, An examination of the discounts and premiums of closed-end investment companies, Journal of Business Research 1, 129-140. Sharpe, W. and H. Sosin, 1974, Closed-end investment companies in the United States: Risk and return, Proceedings of the European Finance Association, 37-63. Stigler, G., 1966, The theorv of DtiCe. 3rd ed. (Macmillan. New York) Thompson, R., 1978, The mfor&mation content of discounts and premiums on closed-end fund shares, Journal of Financial Economics 6, 151-186. Walters, J., 1973, Discussion of Boudreaux. Journal of Finance 28. 538-539. Weisenberger, A., various years, Investment companies (Warren, Gorham & Lamont. New York). Zweig, M., 1973. An investor expectations stock price predictive model using closed-end fund premiums, Journal of Finance 28. 67-78.
of Financial
Economics
13 (1984) 491- 507. North-Holland
‘OPEN-ENDING’
CLOSED-END
Greggory
FUNDS
A. BRAUER*
Uniuersi~ of Iowa, Iowa City. IA S2242, USA Received
September
1982, final version received June 1984
Open-ending a closed-end fund forces the price of the fund’s shares to their net asset value. Open-ending behavior is shown to correspond in predictable ways to the incentive to open-end and to potential resistance to open-ending. Moreover, closed-end fund share prices begin to generate statistically significant positive abnormal returns well in advance of the formal announcement of the open-ending. Although a small part of the total abnormal return is not entirely exhausted until after the announcement, such market price performance is broadly consistent with a semi-strong form efficient market.
1. Introduction Closed-end funds differ from open-end, or mutual, funds in that they rarely issue or redeem their own securities, whereas mutual funds stand ready to sell or repurchase their shares at net asset value per share (value of securities held less liabilities all divided by number of shares outstanding). Consequently, while a mutual fund’s shares trade at their net asset value, the price of a closed-end fund’s shares need not equal their net asset value. The resulting discounts and premiums on closed-end funds have attracted the attention of several authors.’ Malkiel (1977) summarized many of the attempts to explain discounts and premiums and found three useful variables: the tax liability associated with unrealized capital gains, fund policy with respect to the distribution of capital gains, and fund holdings of relatively illiquid letter stocks and foreign securities. The effects of these three considerations, however, ‘. _. explain only a small part of the discounts that exist’ [Malkiel (1977, p. 857)]. Malkiel (1977, p. 858) concluded that the remaining unexplained discount is ‘ . . . an example of a market imperfection in the valuation of capital *I would like to thank Tom Cook, Wayne Ferson, Forrest Nelson, Mike RozeK, Gerry Salamon, Clifford Smith, and the referees for this Journal, Rex Thompson and Marc Reinganum, for their valuable comments. All remaining errors are the author’s sole responsibility. This project was supported in part by a research fellowship grant from the University of Iowa. ‘See, for example, Pratt (1966), Boudreaux (1973), Roenfeldt and Tuttle (1973), Walters (1973), Zweig (1973), Sharpe and Sosin (1974), Hanna (1977), Ma&e1 (1977), Mendelson (1978). Thompson (1978), Richards, Fraser and Groth (1979) and Leonard and Nobel (1981).
0304-405X/84/S3.00@198;1,
Elsevier Science Publishers
B.V. (North-Holland)
492
GA. Brauer, ‘Open-ending’ closed-end fur&
assets’. Thompson (1978) drew a similar inference after an extensive investigation of the returns to portfolio strategies based on closed-end fund discounts and premiums and evaluated against capital asset pricing model specifications of risk-adjusted return. His finding that ‘. . . discounted closed-end fund shares tend to outperform the market, adjusted for risk.. .’ led him to conclude that ‘ . . . it is not possible to identify the extent to which the results reflect capital market information inefficiency as opposed to a breakdown in the applicability of two-parameter asset pricing theory’ [Thompson (1978, p. 182)]. This paper investigates the rationality and informational efficiency of the market for closed-end fund shares by examining ‘open-ending’ behavior. The term open-ending will be used to refer to a class of events designed to force the market price of a closed-end fund’s shares to net asset value. The effects of the incentive to open-end and potential resistance to open-ending will be investigated and the speed with which the share price reacts to open-ending information will be evaluated. Since discounts and premiums have not been fully explained, this exercise is analogous to Stigler’s (1966) discussion of Christmas clubs that pay no interest. Although certain aspects of observed behavior may be incompletely understood (the existence of Christmas clubs or closed-end fund discounts and premiums), useful economic theories still have the power to predict other aspects of behavior (changes in Christmas club balances in response to changes in interest rates or price reaction to open-ending). The remainder of the paper is organized as follows. Section 2 will describe open-ending in more detail and investigate the incentive to open-end and a potential source of resistance to open-ending. Section 3 will examine the share price reaction to open-ending information. Section 4 concludes the paper. 2. Open-ending:
Evidence on why some funds do and other funds do not
Open-ending events are usually initiated by shareholders hoping to eliminate the discount from net asset value at which most closed-end funds sell. At least three organizational changes will force a share’s price to its net asset value. The most obvious option is simply to change the form of the fund from closed-end to mutual. The same result can also be achieved by merging a closed-end fund with a mutual fund. Liquidating the fund’s assets and distributing the proceeds also increases the value of the claim represented by fund shares.2 Table 1 presents a list of closed-end funds that have been open-ended since 1960. Advance Investors, Boston Personal Property Trust, Carriers & General,
‘There are, of course, transaction costs involved that will prevent the share price from going to exactly its net asset value. The case of Consolidated Investment Trust is an example. The trust announced in 1967 that it would liquidate, but at the end of 1981 about half the shares outstanding in 1966 were still outstanding and selling at a discount of two to three percent. The fund stands ready to redeem outstanding shares at net asset value, but has the option of making the redemption in cash or securities. The transaction costs of liquidating the securities the fund might distribute presumably accounts for the continuing discount.
493
G.A. Bmuer, ‘Open-ending’ closed-end funds Table 1 Closed-end
funds that have been open-ended
Fund name M.A. Hanna Boston Persona1 Property Trust Consolidated Investment Trust Surveyor Dominick International Holdings Gtiesedick Advance Investors American Utility Shares Keystone OTC Fund United Corporation National Aviation&Technology Carriers & Genera1 Chase Convertible Fund of Boston
since 1960.
Fund investment policy A
Month and year of official announcement of impending open-ending
ND&S DIV DIV DIV DIV DIV DIV DIV ND&S ND&S ND&S ND&S DIV SS
lo/65 l/66 3/67 9/73 IO/74 8/75 4/76 7/76 11/77 12/77 l/78 7/78 5/81 11/81
a ND&S indicates non-diversified and specialized funds, DIV indicates diversified funds. and SS indicates senior security funds. Classifications from Inoesttnent Compunies by Arthur Weisenberger.
and National Aviation & Technology were all straightforward reorganizations from closed-end funds to mutual funds. Chase Convertible Fund of Boston was reorganized into a series of the Phoenix-Chase Series Fund. The Keystone OTC Fund was combined with the Keystone Apollo Fund to form the mutual Polaris Fund. American Utility Shares was merged into the Lord Abbet Fund, Dominick was merged into Putman Investors Fund, International Holdings was merged into Cheapside Dollar Fund, and Surveyor was merged into Eberstadt Fund. All the latter partners were mutual funds. United Corporation was in part merged into D.H. Baldwin Company and in part liquidated. Consolidated Investment Trust, Griesedick, and M.A. Hanna were liquidated. The information dates cited in the table are the earliest months in which an apparently irreversible decision to open-end was made and announced. They range from the same month in which the open-ending occurred to several months in advance of the actual effective data of the open-ending. 2.1. The incentive
to open-end
The obvious incentive for open-ending is the return associated with eliminating the discount.3 The premium, P, on a closed-end fund is conventionally ‘In fact, Benl’min Graham is reputed to have said, in reference to closed-end funds: ‘The price discount of these companies may be viewed as an expensive moment erected to the inertia and stupidity of stockholders. It has cost the owners of these businesses countless millions of dollars, yet it has been totally unnecessary. It could have been terminated at any time by the mere passing of a resolution at a stockholder’s meeting’ (Hetzfeld (1980, p. 181)].
494
calculated
G.A. Brauer, ‘Open-ending’closed-endfunds
as P=(Price-NAV)/NAV,
(1)
where NA V is the net asset value and a discount is, of course, negative premium. The rate of return to shareholders, R, from forcing a fund’s price to NAV may be defined as R = ( NA V - Price)/Price,
simply a costlessly
(2)
or, in terms of the fund’s premium, R=
-P/(l+P).
(3)
A testable hypothesis about the incentive to open-end consequently is that the closed-end funds which open-end have a smaller premium than the closed-end funds which do not open-end, ceteris paribus. Two issues are relevant to the test of this hypothesis. First, since closed-end funds voluntarily restrict the compositions of their portfolios, they must be exploiting some capital market imperfection to an end that their managers feel will outweigh the investment inefficieltcy associated with not holding a more well diversified portfolio. The same imperfection might well lead to an incentive to open-end that is conditional upon the type of investment restrictions undertaken. Second, since effecting an open-ending takes time, the relevant point for evaluating the strength of the incentive to instigate open-ending is in advance of the actual event. fund one year before the Let POE denote the premium on an open-ended open-ending. Let FT denote the average premium on matching closed-end funds (i.e., funds with the same type of investment policy at the same time). for the The average POE, FOE, is an estimate of the true averag~premium population of open-ended funds, aOE. The average Fr, P,, is an estimate of the true average premium on the population of matching funds which were not open-ended, (Ye. Formally then, the first set of testable hypotheses is Hh : aOE = aT
versus
Hi : aOE -c a+.
These hypotheses can be evaluated using a variance-corrected paired comparison of POE and Fr. values.4 Note that the specificity of the alternative hypothesis dictates a one-tailed test. 4Since 7, is an average, its variance is smaller than the variance of POE and a correction to the standard paired r-test is required. The difference metric is do, = (P,, - (l/F)E/F=, P,), where there are F matching funds. Assuming the premiums are independently distributed, the variance of d,, is u2 = (I& + (l/F*)~&,u_). where c& is the variance of P and e* is the variance of the f th matching premium. If boa = e,= e for all OE and f values, zj simpljfes to ~‘(1 + l/F). This can be incorporated into the test ,by redefining the difference metric as d& = d&C, where the correction factor is c = (1 + l/F)?. This corrected difference was used because the choice of one of the F possible matches would have been arbitrary.
GA. Brauer, ‘Open-ending’closed-endfunds
495
Table 2 presents the data and test for the first pair of hypotheses. Data were gathered from The Wall Street Journal ‘Closed-End Fund’ and ‘Publicly Traded Fund’ sections (except as noted) for one year in advance of the announcement date cited in table 1. The average shareholder return from costlessly open-ending the fourteen funds was 30.9%. The average return that could have been earned by open-ending all of the same types of funds at the same respective times would have been 19.3%. The 7.4% larger average discount on the funds that were, in fact, open-ended is consistent with Ha and significant at the 0.006 level. In other words, while there is on average an incentive to open-end all closed-end funds, the incentive is statistically significantly greater for the funds which are actually open-ended.
Table 2 A variance-corrected paired comparison test of the hypothesis open-ended have on average the same premium as similar open-ended.
Open-ended
fund
M.A. Hannab Boston Pers. Plop. Trust Consolidated Invest. Trust Surveyor Dominick International Holdings Griesedickb Advance Investors American Utility Shares Keystone OTC United Corporation National Aviation & Tech. Carriers & Generalb Chase Convertible Fund Average
Premium measurement datea (month/year) 12/63 6/65 2/66 g/72 9/73 l/74 12/74 6/75 lo/76 11/76 12/76 3/77 12/79 lo/go
premium Average premium
that closed-end funds closed-end funds that
Open-ended fund premium (in percent)
Premium information similar funds Average premium (in percent)
- 20.0 - 26.4 - 18.4 ~ 25.9 -26.1 - 21.4 - 38.0 ~ 27.0 1 20.3 ~ 27.7 - 12.9 - 32.3 - 15.1 - 19.1
~ 23.3 - 10.1 ~ 10.4 - 15.4 - 17.7 - 17.9 ~ 22.1 - 22.4 - 22.3 - 12.3 - 23.1 -21.4 - 14.7 6.1
- 23.6
~ 16.2
difference
that are are not
for
Number of funds ___11’ 20d 24d 34d 13’ 14e 13’ 13’ 18s 16g 12’ 189 14’ 16g
= ~ 7.48
r-score = - 2.96 Significance
levelh = 0.006
“Premium measured at the end of the month one year before open-ending announcement. bData taken from Inuestmenr Compumes by Weisenberger because more timely information was not available in The Wull Sweet Journul. “‘Non-diversified’ funds, dAll funds; report did not catagorize funds by type. e‘Diversitied common stock’ funds. “Diversified’ funds. @Specialized equity and convertible’ funds. hTo reject the null hypothesis of equal premiums in favor of the alternattve hypothesis that the open-ended fund average is less.
496
2.2. Resistance
G.A. Brauer, ‘Open-ending’ closed-endfunds
to open-ending
If open-ending funds selling at a discount is profitable for shareholders (even though not uniformly so), there must be some reason why every closed-end fund is not immediately reorganized when its share price drops below its net asset value. A possible counteracting effect derives from the nature of the owner-agent relationship between shareholders and managers. Simply stated, open-ending threatens what Jensen and Meckling (1976) would call a fund manager’s ‘wealth and non-pecuniary benefits’. In the absence of golden parachutes activated by open-ending, managers would obviously resist liquidation. Similarly, merger threatens management wealth and perquisities. However, simple conversion to mutual fund status would be resisted only if managers of closed-end funds can extract more ‘wealth and non-pecuniary benefits’ that can managers of mutual funds. In order to determine if the agency relationship does give rise to open-ending resistance, two additional hypotheses must be investigated. Is a measure of management wealth and perquisites less for closed-end funds that are open-ended than for closed-end funds that are not open-ended, ceteris paribus? Is the measure greater for all closed-end funds than for all mutual funds, ceteris paribus? A fund’s expense ratio as reported by Weisenberger’s annual Investment Companies appears to be a reasonable proxy for the portion of its manager’s ‘wealth and non-pecuniary benefits’ produced by the fund. Relative to the expenses of investment funds Weisenberger (1982, p. 16) says: ‘All investment companies have operating expenses. Normally, the management fee is the largest part of the total. . . . this fee covers the salaries of fund officers and other personnel, as well as the cost of office space and facilities, in addition to the payment of portfolio management. . . . Brokerage costs are considered capital items, rather than fund expenses.. . .’ Further, any taxes paid are not included in the calculation of reported expenses. A fund’s expense ratio is its total expenses divided by its total net asset value. Since expenses obviously depend on fund size, expense ratios are a more appropriate measure of relative resistance than expenses in dollars. Also -in the interests of the ceteris paribus condition, a fund’s expense ratio should be compared to the average ratio for funds with similar investment restrictions. To formalize the hypothesis that open-ended closed-end funds reported smaller expense ratios than similar funds that were not open-ended, let ER.. denote the last reported expense ratio for an open-ended fund. Let m, denote the average expense ratio for closed-end funds with the same type of investment policy. In order to hold the effects of general market conditions constant, and its matching ER, should be measured over the same period. The E&E is an estimate of the true average expense ratio for the average ER oE, ?%,,, is an estimate of population of open-ended funds, yOE. The average ER,,E,,
GA. Brauer, ‘Open-ending’ closed-end funds
497
the true average expense ratio for the population of funds with the same type of investment policies at the same time as the open-ended funds, yr. Formally then, the second set of testable hypotheses is Hi:
Y~E = -tr
Hi : yOE -c yr.
versus
These hypotheses can be evaluated using ERO. and ER, in a variance-corrected paired comparison. The specificity of the alternative hypothesis again dictates a one-tailed test. Table 3 presents the data and test for the second pair of hypotheses. Data were gathered from the ‘Statistical Survey of Closed-End Funds’ section of Weisenberger’s Investment Companies for the last complete year preceding each open-ending announcement. The 0.22% smaller average expense ratio for the funds that were, in fact, open-ended is consistent with Hf, and significant at the 0.025 level. In other words, if the expense ratio is a reasonable proxy for management resistance to open-ending, the resistance is on average statistically significantly less for the funds which are actually open-ended. Table 3 A variance-corrected paired comparison test of the hypothesis that closed-end funds have on average the same expense ratio as similar closed-end funds that are not open-ended
Open-ended
fund
Open-ended fund expense ratio (in percent)
Average expense ratio (in percent)
Number of funds
1964 1965 1966 1972 1973 1974 1974 1975 1976 1976 1976 1977 1980 1980
0.21 0.18 0.13 0.80 0.83 0.72 0.57 1.17 1.04 1.29 0.82 0.97 1.24 0.90
0.x9 0.52 0.57 0.58 0.59 0.81 0.81 0.88 1.75 1.75 0.74 1.48 0.94 1.65
9” 20b 20h 14h 13h 14b 14a 12h 19s 19’ 6’ 17’ 14h loc
M.A. Hanna Boston Pers. Prop. Trust Consolidated Invest. Trust Surveyor Dominick International Holdings Griesedick Advance Investors American Utility Shares Keystone OTC United Corporation National Aviation & Tech. Carriers & General Chase Convertible Fund Average
Expense ratio information for similar funds
Last reported year before the open-ending announcement
expense ratio
0.78 Average expense ratio difference
1.00 = ~ 0.22%
t-score = 2.12 Significance “ Non-diversified’ funds. b‘Diversitied’ funds. “Specialized’ funds. ‘TO reject the null hypothesis open-ended fund average is less.
of equal
ratios
leveld = 0.025
in favor of the alternative
hypothesis
that the
GA. Bmuer, ‘Open-ending’ closed-end funds
498
Herzfeld (1980) catalogues many of the arguments against open-ending made by closed-end fund managers. An interesting artifact of his discussion is the identification of the following five open-endings as having been accomplished without significant management obstruction: M.A. Hanna, Boston Personal Property Trust, Surveyor, Griesedick, and Keystone OTC. Moreover, the following five open-endings apparently were achieved over the significant objections of fund directors: Dominick, International Holdings, Advance Investors, American Utility Shares, and National Aviation & Technology. The remaining four funds are not classified by managerial resistance. If expense ratio is a reasonable proxy for managerial resistance, then the average expense ratio of the low-resistance group should be less than the average for the high-resistance group. This is precisely the case. The low-resistance group had an average expense ratio in the year preceding announcement of 0.61% versus an average for the high-resistance group of 0.95%. These are comparisons of raw ratios, however. When matching is used to hold the effects of different investment policies and different general economic conditions constant, the low-resistance group had an average expense ratio 0.30% less than their matching funds, while the high-resistance group had an average expense ratio only 0.16% less than their matching funds. Although groups of five are too small to demonstrate statistical significance, the differences for the low- and high-resistance subsamples are consistent with the expense ratio performing as a reasonable proxy for degree of management resistance. To formalize the hypothesis that on average closed-end fund expense ratios are larger than expense ratios for comparable mutual funds, let ERc. denote the expense ratio on any closed-end fund from 1965 through 1981 (the time period during which open-endings occurred), and let ER, denote the expense ratio on a matching mutual fund. Since trades of closed-end fund shares take place in a transactionally costly secondary market, closed-end funds should be matched only with load type mutual funds. As before, both funds should have the same investment restrictions and both ratios should be for the same year. is an estimate of the true average expense ratio for The average ER =-, @.,, the population of closed-end funds, yCE. The average ER,, ER,, is an estimate of the true average expense ratio for the population of mutual funds, y,,,,. Formally, a third set of hypotheses is H,~:Y~E=YM
versus
Hi : yCE > yw.
These hypotheses can be evaluated using ER,, comparison.s Again, a one-tailed test is indicated.
and
ER,
in a paired
5To break the ties when more than one mutual fund match was found on the basis of load, investment policy, and time period, the mutual fund of most nearly the same size (by total net asset value) was selected. This method of handling ties is an alternative to the variance-correction approach discussed in footnote 4. While this method collects less information per match (although fund size is not an entirely arbitrary tie-breaker), the much larger sample size here makes for a powerful test.
G.A. Brauer, ‘Open-ending’ciosed-end funds
499
Table 4 presents the data and test for the third set of hypotheses. The data were gathered from Weisenberger’s Investment Companies for each of the seventeen years covered by table 1. The closed-end fund expense ratios are reported in the ‘Statistical Survey of Closed-End Funds’ section and the matching mutual fund ratios were selected from the ‘Statistical Survey of Mutual Funds’ or ‘Mutual Funds Panorama’ sections. While the average expense ratio difference was always in the predicted direction, it was not always statistically significant at conventional levels. Over all 826 pairs, however, the 0.21% larger average ratio for closed-end funds is consistent with Hi and extremely significant. In other words, on average closed-end fund managers face a statistically significant loss in ‘wealth and non-pecuniary benefits’ if their funds are reorganized into mutual funds.
2.3. Additional
evidence
The evidence questions. First,
presented to this point suggests two additional interesting can relative premiums and expense ratios be used simulta-
Table 4 A paired
Year(s) 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1965-1981
comparison
test of the hypothesis that closed-end funds expense ratios as similar mutual funds.
have on average
the same
Average of closed-end fund expense ratio minus mutual fund expense ratio (in percent)
t-score
42 42 41 37 39 39 36 32 51 67 66 61 56 54 57 55 51
0.0929 0.0612 0.0527 0.0549 0.1167 0.0664 0.1939 0.1322 0.2525 0.3199 0.2895 0.3236 0.3070 0.1863 0.2632 0.2744 0.2541
0.99 0.76 0.61 0.62 1.13 0.82 2.09 1.29 2.67 2.92 2.92 2.50 2.90 2.02 2.35 2.01 2.83
0.1631 0.2266 0.2741 0.2706 0.1322 0.2093 0.0218 0.1035 0.0051 0.0024 0.0024 0.0075 0.0027 0.0240 0.0112 0.0249 0.0034
826
0.2088
8.05
i 0.0001
Number of closed-end fund and mutual fund pairs”
Significance levelb
‘Number of closed-end funds for which a ‘meaningful’ expense ratio was reported in Weisenberger’s InvestmentCornponies. bTo reject the null hypothesis of no difference in expense ratios in favor of the alternative hypothesis that closed-end fund expense ratios are greater.
G.A. Bmuer, ‘Open-ending’
500
ciosed-end funds
neously to form a predictive model of open-endings? Second, while cross-sectional comparisons have been conducted in the interests of holding the effects of general market conditions constant, are the premiums and expense ratios immediately before the open-ending smaller than their own historical averages? With respect to the first question, a reasonable model of open-ending can be constructed using relative premiums and expense ratios. Let y be a binary variable for fund i taking on the value one for an open-ended fund or the value zero for a fund which remains closed-end. Let Pi’ = P, - PT where Pi is the premium on closed-end fund i. Let ER: = ER, - m, where ER, is the expense ratio for closed-end fund i. The model is t = a, + a,P,‘+ a,ER;
+ Z,,
where a,, a,, and a2 are coefficients to be estimated, and ,Zi is an error term. The estimated values of a, and a2 should be significantly negative according to the incentive and resistance hypotheses. Binary dependent variables are known to cause standard t-test statistics not to be distributed according to the r-distribution and to cause coefficient variance estimates to be biased. However, Mosteller and Tukey (1977) have demonstrated a convenient hypothesis-testing technique (called jackknifing) for binary dependent variable regression coefficients. A random sample of 14 closed-end funds was drawn from the 826 observations used to test hypothesis Hi and combined with the 14 open-endings to create a set of 28 observations over which the coefficients for eq. (4) were estimated and tested using jackknifing.6 The estimated coefficient values were 0.420 for a,, - 0.012 for a,, and -0.368 for a2. The estimates of a, and a2 were significantly different from zero at the 0.025 and 0.050 levels, respectively. These results are consistent with the incentive and resistance hypotheses. In place of the inappropriate F-test, jackknifing provides an assessment of the asymptotic ability of the model to sort out open-ended from non-open-ended funds. Only about 57% of the funds would be correctly classified if (4) could be estimated over an infinite number of observations. While cross-sectional differences in premiums and expense ratios are useful in predicting open-endings, they clearly do not capture all relevant considerations. Moving to the second question, recall that the goal of cross-sectional matching was to hold the effects of general economic and market conditions constant. Matching pre-open-ending premiums and expense ratios with their respective historical averages may result in weaker tests of the incentive and resistance hypotheses. As a descriptive exercise, however, a time-series comparison yields some additional insight. ‘Details
about
this procedure
are available
from the author.
GA. Brauer, ‘Open-ending’ closed-end funds
501
All the premiums that could be found in either The Wall Street Journal or Investment Companies for the two years immediately preceding the measurement dates in table 2 were collected for each of the open-ended funds. The fund-by-fund averages of these historical premiums were matched with their respective pre-open-ending premiums as reported in table 2 and a variancecorrected paired comparison test was performed. The historical average premium for the 14 funds was -22.2%, compared to the average pre-open-ending premium of - 23.6%. Consequently, the open-ended funds were, indeed, selling at a larger than (time-series) average discount one year before the announcement. This observation is consistent with the incentive hypothesis. The t-score for the paired comparison test is, however, only -0.97 and not significant at conventional levels. All the expense ratios reported in Investment Companies for the post World War II years preceding the measurement dates in table 3 were collected for each of the open-ended funds. The fund-by-fund averages of these historical ratios were matched with their respective pre-open-ending ratios as reported in table 3, and a variance-corrected paired comparison test was performed. The historical average ratio for the 14 funds was 0.66% compared to the average pre-open-ending ratio of 0.78%. Consequently, the expense ratios of open-ended funds in the last year before the announcement were, in fact, larger than their historical averages. This observation is apparently precisely contrary to the resistance hypothesis. Moreover, the t-score from the paired comparison test is 2.55 and significant at the 0.014 level. The jackknifing tests of the simultaneous effects model, eq. (4) concluded that, while cross-sectional relative premium and expense ratio information was useful in ways consistent with the incentive and resistance hypotheses, additional considerations obviously were also relevant. A case can be made that a significant increase in the expense ratio represents such an additional consideration. Because the reported net asset value does not include the capitalized value of future expenses, it overstates the true net asset value (based on future cash inflows from assets owned and future cash outflows to asset managers). This net asset value overstatement implies that the reported discount overstates the true discount. The incentive to open-end is presumably related to the size of the true discount.’ An increase in the expense ratio will cause the true discount to go up by more than the increment in the reported discount if the higher level of expenses is expected to be maintained into the future. As a result, an increase in the expense ratio may be a signal to shareholders to increase open-ending pressure. Expense ratios hence provide information about the relative resistance hypothesis in cross-sectional comparisons while also providing information about the incentive hypothesis in time-series compari‘Tests of the incentive hypothesis have consequently been using an instrumental using the observable reported discount instead of the unobservable true discount.
variable
by
G.A. Brauer, ‘Open-ending’
502
closed-end funds
sons. Empirically, the pre-open-ending increase in expense ratios was significant and associated with an insignificant increase in reported discounts but an obviously significant increase in open-ending pressure.
3. Open-ending: The market reaction Having seen that the open-ending evidence is consistent with rational behavior by fund owners and managers, consider now the capital market reaction to open-ending. Specifically, if the market for closed-end fund shares is at least semi-strong form efficient, then the shares of funds which are open-ended should begin to exhibit abnormal positive returns immediately upon the public announcement that the fund will be open-ended.’ Since some information about the prospects for an open-ending will very probably have leaked into the market in advance of the official announcement. abnormal return performance might even be observed over the pre-formal-announcement period. However, the statistical hypotheses to be tested in this section will be formally stated as9 Hi: No average abnormal return are open-ended immediately the pending open-ending. versus
on the shares of closed-end funds which after the first official announcement of
Hi: Positive average abnormal return on the shares of closed-end funds which are open-ended immediately after the first official announcement of the pending open-ending.
3. I. Methodology The technique used to measure abnormal returns was developed by Fama, Fisher, Jensen and Roll (1969). The statistical significance of the abnormal returns is determined using the procedure developed by Jaffe (1974) and Mandelker (1974).
‘Thompson (1978) showed that the equally-weighted average return on closed-end funds’ typically discounted prices is not significantly different from the risk-adjusted return predicted by an equilibrium model of asset pricing. (See his table 4.) Since the event of open-ending forces the discounted price to net asset value, it must on average generate abnormal returns. ‘Thompson (1978) also showed that portfolios constructed using weights based on discount information earn abnormal returns (even though on equally weighted average, closed-end funds provide a normal risk-adjusted return). Since open-ending is related to discount, in order to ensure that the market efficiency hypotheses tests do not simply replicate the abnormal return performance documented by Thompson, the hypotheses could more accurately be stated in terms of ‘average abnormal returns in excess of those found by Thompson’. As will be seen below, the abnormal returns associated with open-ending are very much huger than those reported by Thompson.
GA. Brauer, ‘Open-ending’ closed-end junh
Let some model of the process normally fund i in period t be represented as
generating
503
the return
on shares of
k, =f(X,) + z,,,
(5)
where ii,, is the normal return to fund i in period t based upon some set of return determinants in r denoted X, (which does not include information about open-ending) and I,, is a random error term unique to fund i in period t. The variable Z,, is usually assumed to have a zero expected value, constant variance through time, no serial correlation, and no correlation with any part of X,. The ex-post abnormal return for fund i in period t may be defined as
(6)
AR,, = R,, -f(4),
where R,, is the observed return on fund i in period t. To reduce the impact of random measurement errors of X,, the Fama-Fisher-Jensen-Roll method averages the abnormal returns across funds for each t relative to the information event as follows:
AR, = 5 ARir/N.
(7)
r=l
where N is the number of funds. These average lated over the period from k to t by
CAR,=
i
abnormal
returns
AR,.
are cumu-
(8)
/=k
The Jaffe-Mandelker test forms equally weighted portfolios in calendar-time which are consistent with the event-time frames used to generate the average and cumulative abnormal returns. By forming a calendar-time portfolio, the contemporaneous correlations between security returns are reflected in the portfolio performance and the excess portfolio returns can be treated as independent. The standard deviation of past excess portfolio returns can then be used to standardize the current excess return and form a test statistic. For month m in calendar-time, when a strategy calls for the ownership of at least one stock, the abnormal return on the portfolio held is denoted PAR,,,. The variability of this abnormal return is estimated by the following standard deviation:
PAR,-
$
“i’ q=m-60
PAR,
.
(9)
GA. Brauer, ‘Open-ending’closed-endfunds
504
The standard deviation estimate return in period m as follows:
is used to standardize
the abnormal
portfolio
PARS, = PAR,/s,. The standardized are averaged by
(10)
abnormal
portfolio
returns
for a given strategy
through
time
675 PAR’=
(l/n)
c cm0
=
(11)
PAR”,,,, 454
where the time index cmo is denominated in months as defined by the Center for Research in Security Prices at the University of Chicago (CRSP). CRSPmonth 454 is 24 months before the information date for M.A. Hanna, and CRSP-month 675 is the last CRSP-month for which data is available for Chase Convertible Fund of Boston. In eq. (11) n is the number of months in which a portfolio consisting of at least one security was held. The test statistic to determine the significance of the average standardized monthly abnormal return to a portfolio strategy is tp =EJZ/(l/n:), and is distributed
according
(12) to Student’s
t.
Monthly information on shares outstanding, share prices, and dividends were collected for the open-ended funds from the CRSP monthly tape, from Weisenberger’s Investment Companies, from The Wall Street Journal, and from the New York Times.
3.2. Results The market model holds that the return to security i in period determined by a process that can be represented as follows: A,, = b,i + bi,Rmt + P,,,
t is
(13)
where R,, is the return on some widely-based market index in period t and b,, and b,; are parameters unique to security i. lo Reserve the t subscript for time
“Ingersoll (1976) has used an alternative model, the option pricing model, to investigate dual purpose funds, Dual purpose funds are like closed-end funds except that they have an exphcit maturity date. Ingersoll concludes that regular closed-end funds will sell at a discount whenever a fund must pay management fees and ‘ fund shares are not redeemable at asset value’. His second condition may be interpreted as open-ending being transactionally costly. Malkiel’s (1977) investigation of the impact of management fees found their effect to be too small to explain the size of observed discounts. He did not, however, address the cost of open-ending.
GA. Brauer, ‘Open-ending’ closed-end funa!s
505
relative to the information event. To allow for potential instability in the estimates of b,, and b,;, ordinary least squares regressions were used to estimate ba,, and but for values of t ranging from - 24 to - 1 by estimating
k” = bo,,+ blr*Rmv + P,“,
(14)
using values of u from t - 60 to t - 1 and the CRSP value-weighted total return (dividends plus price appreciation) market index. Abnormal returns were then
Table 5 presents the average abnormal returns and two cumulative abnormal returns (from k = - 12 and from k = + 1) that resulted from using the market
Table 5 Abnormal monthly returns (in percent) surrounding the announcement of an open-ending using the market model as the normal return generator (14 open-endings from 1960 through 1981). Event time - 12 -11 - 10 - 9 - 8 - 7 ~ 6 - 5 - 4 ~ 3 - 2 - 1 0 + 1 + 2 + 3 + 4 + 5 + 6 + I + 8 + 9 + 10 +11 + 12
Average abnormal return”
Cumulative abormal return’
- 0.1069 3.1832* - 0.4664 2.2061 ~ 0.8522 2.9413* -0.1192 3.9296** - 0.6934 2.1490 1.4693 3.4124** 5.1755** 4.1050* 1.6118 3.5411* - 2.3653 1.3121 - 1.7981 2.7653 ~ 0.0557 - 0.8753 -0.1918 -0.3118 - 1.7175
-0.1069 3.0763 2.6099 4.8166 5.6688 X.6101* 8.4909* 12.4205** 11.7271** 13.8761** 15.3454** 18.7578*** 23.9333*** 28.0383** 29.6501* 33.1912* 30.8259 32.1380 30.3399 33.1052 33.0495 32.1742 31.9824 31.6706 29.9531
Cumulative abnormal return”
4.1050s 5.7168 9.2579* 6.8926 8.2047 6.4066 9.1719 9.1162 8.2409 8.0491 7.1373 6.0198
a* indicates significant at the 10% level, ** indicates significant at the 5% level, and *** indicates significant at the 1% level to reject the null hypothesis that the standardized counterparts are zero in favor of the alternative hypothesis that they are positive.
506
GA. Brauer, ‘Open-ending’ closed-end funds
model to generate normal returns. l1 The table has a number of interesting features. First, the 25 average abnormal returns ranged from -2.4% to 5.2%, with 14 positive and 11 negative. Notice that the largest average abnormal return was in the announcement month. Second, when those average returns are cumulated starting 12 months before the information event date, a series of positive cumulative returns was built up over the first 14 months, and then the series became generally stable over the last 11 months, accumulating a positive abnormal return of nearly 30% over the two years. Even though the unstandardized CAR’s remained above the month zero level through month +12, their significance fell dramatically due to the number of funds dropping out of the sample soon after the announcement date. In fact, only three funds survived past event-month three. Finally, when the average abnormal returns were cumulated over just the 12 months following the information event, a 6% abnormal return resulted. Although the CAR’s were all positive, the last conceivably significant standardized value was in month three. These patterns are consistent with cross-sectionally large discounts on the funds during the second year before they are open-ended (approximately 24% on the funds which are open-ended compared with an average discount on all closed-end funds of about 16%). In the one year before the information event used in this study, news of the potential, and as yet uncertain, event appears to have been leaking into the market causing the discounts to narrow and the returns to begin exhibiting abnormal positive performance. While most of the abnormal performance was exhausted by month zero, a strategy of buying shares upon the announcement and holding them for three months would have been rewarded with abnormal returns. l2 These returns could be interpreted as resulting from the resolution of any lingering uncertainty about the openending even after the fund’s official announcement. Strictly speaking, however, Hi can be rejected in favor of Hi. 4. Conclusion Three main results about closed-end funds have been demonstrated. First, open-ending activity accords well with the shareholder incentive to open-end provided by share price discounts from net asset value. Second, open-ending activity also corresponds to managerial resistance to the loss of ‘wealth and “A check type. Also, addition to reported in
of returns from I = - 24 through I = - 13 showed no abnormal performance of any a multi-index model using an orthogonahzed closed-end fund industry index (in a market index) was investigated. The results were not significantly different than those table 5.
‘*Note that the 9.26% CAR from event month + 1 through + 3 is gross of transaction costs. TO remain statistically significantly different from zero, the CAR net of transaction costs would have to have been greater than about 7.00%. Transaction costs in the neighborhood of 2.26% may not be beyond reason.
GA. Brauer, ‘Open-ending’closed-endfunds
507
non-pecuniary benefits’ caused by open-ending. Third, while abnormal returns were possible from buying the shares of open-ended funds in the announcement month and holding them for three months (to the extent that funds remained closed-end for as long as three months after the announcement), most of the abnormal return associated with open-ending was exhausted by the end of the announcement month. With respect to open-ending, the behavior of closed-end fund participants is generally rational and the market for closed-end fund shares is generally efficient. If these traits are characteristic of closed-end funds in general, then the persistent discounts at which most funds sell must have a rational explanation in an efficient market. In other words, claims that the unexplained (and majority) portion of closed-end fund discounts are due to an ‘imperfect’ or inefficient market now seem less warranted. References Boudreaux, K., 1973, Discounts and premiums on closed-end mutual funds: A study in valuation, Journal of Finance 28. 515-522. Bricklev, J. and J. Schallheim, 1983, Lifting the lid on closed-end investment companies: A case of abnormal returns, Working paper (University of Utah, Salt Lake City. UT). _ Fama. E.. L. Fisher. M. Jensen and R. Roll, 1969. The adtustment of stock urices to new information, International Economic Review 10, 1-21. Hanna, M., 1977, An investor expectations price predictive model using closed-end fund premiums: Comment, Journal of Finance 32, 1368-1371. Herzfeld, T., 1980, The investor’s guide to closed-end funds (McGraw-Hill, New York). Ingersoll, J., 1976, A theoretical and empirical investigation of the dual purpose funds, Journal of Financial Economics 3, 83-123. Jaffe, J., 1974, Special information and insider trading, Journal of Business 47, 410-428. Jensen, M. and W. Meckling, 1976, Theory of the firm: Managerial behavior. agency costs and ownership structure, Journal of Financial Economics 3. 305-360. Leonard, D. and N. Nobel, 1981, Estimation of time-varymg systematic risk and investment performance: Closed-end investment companies, Journal of Financial Research 4. 1099120. Malkiel, B., 1977, The valuation of closed-end investment company shares. Journal of Finance 32. 847-859. Mandelker, G., 1974, Risk and return: The case of merging firms, Journal of Financial Economics 1, 303-335. Mendelson, M., 1978, Closed-end fund discounts tevisited, Financial Review. Spring. 48-72. Mosteller, F. and J. Tukey, 1977, Data analysis and regression (Addison-Wesley, Reading, MA). Pratt, E., 1966, Myths associated with closed-end investment company discounts, Financial Analysts Journal, July-Aug., 79-82. Richards, R., D. Fraser and J. Groth. 1979, Premiums, discounts, and the volatility of closed-end mutual funds, Financial Review. Fall, 26-33. Roenfeldt, R. and D. ‘Tuttle, 1973, An examination of the discounts and premiums of closed-end investment companies, Journal of Business Research 1, 129-140. Sharpe, W. and H. Sosin, 1974, Closed-end investment companies in the United States: Risk and return, Proceedings of the European Finance Association, 37-63. Stigler, G., 1966, The theorv of DtiCe. 3rd ed. (Macmillan. New York) Thompson, R., 1978, The mfor&mation content of discounts and premiums on closed-end fund shares, Journal of Financial Economics 6, 151-186. Walters, J., 1973, Discussion of Boudreaux. Journal of Finance 28. 538-539. Weisenberger, A., various years, Investment companies (Warren, Gorham & Lamont. New York). Zweig, M., 1973. An investor expectations stock price predictive model using closed-end fund premiums, Journal of Finance 28. 67-78.