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Automatic Opening for a Closed-End Portfolio

May 11, 1997|RUSS WILES

If you purchased one of the many newly issued closed-end funds, you may know the problem: The price of your investment slumped to a discount below what it's really worth, and the directors and management company probably didn't do much about it.

The current prevalence of discounts has turned off many investors and helps explain why closed-end funds have taken a back seat to regular mutual funds. As a result, later this month one fund will try a novel tactic to protect investors.

With both kinds of funds, a financial company pools shareholder dollars and invests the money in a portfolio of stocks or bonds. But a closed-end fund is sold in large chunks, in a process similar to the public offerings of a single company. The closed-end fund issues shares that trade like stocks on major exchanges, and thus its price can move up or down based on investor expectations.

The more familiar open-end mutual funds are priced to the market every day and redeem or sell shares based on that price.

As investors have become more savvy about this peril of closed-end funds, demand has dried up. From 101 new funds in 1992 and 121 in 1993, just 41 funds debuted in 1994, three in 1995 and five last year, reports fund researcher Lipper Analytical Services. "Only a dozen or so brokerage firms have full-time closed-end analysts, and many of the funds are so small that they don't warrant [ongoing research] coverage," says Donald L. Cassidy, a senior research analyst for Lipper Analytical in Denver.

But an unusual wrinkle built into a proposed fund could change all that. The Dessauer Global Equity Fund will convert automatically into a regular mutual fund if at any time after the first 18 months of operation its price trades at a discount of 5% or greater for 15 consecutive days. Dessauer Global Equity is scheduled to be launched this month. "Ideally, the automatic-conversion provision will preclude a meaningful discount from developing," says James J. Atkinson Jr., director of Guinness Flight Global Asset Management in Pasadena. "If it doesn't, however, the automatic conversion to an open-end fund will simply eliminate any discount."

Guinness Flight will jointly run the new portfolio with Dessauer Asset Management of Orleans, Mass. Specifically, Guinness Flight will buy and monitor Asian stocks for the new fund, while Dessauer will invest in American and European companies. The sponsoring companies hope to raise $100 million in the offering. Shares must be purchased through a brokerage.

The automatic-conversion feature is a first for the U.S., although it has been used on closed-end funds in Hong Kong, says Cassidy.

In effect, it represents an alternative to the way closed-end funds typically operate, with self-centered managements, spineless directors and uninterested shareholders. How else can you explain the current scenario? Most closed-end funds trade at discounts, yet "open-ending" provisions to eliminate the markdown are routinely rejected by investors when they come up for a vote.

A fund's management company has a vested interest in retaining the closed-end structure because it means a fairly stable asset base--anyone who sells fund shares must find someone else to buy them--and thus a steady source of fee income.

Directors, who purportedly serve as shareholder representatives, often heed management's wishes. "Open-ending efforts are entirely unsuccessful unless when a board [of directors] favors it," said Cassidy.

Shareholders also deserve part of the blame. When open-ending provisions come up for a vote, many investors fail to cast ballots or blindly check off the actions recommended by the directors. It doesn't help that funds routinely require "supermajority" approval of open-ending proposals, mandating a "yes" vote by anywhere from 67% to 80% of outstanding shares.

John M. Cunningham, an investment advisor in Wayne, Pa., was among a group of investors who in March tried unsuccessfully to convert the closed-end Templeton Global Income Fund into an open-end portfolio.

"Some of my own clients didn't even act on the proposal; they didn't even read the proxy materials to notice that my name was in there," he said. "That's how uninterested some people are."

Cunningham, who estimates that he and his clients own about 300,000 shares of Templeton Global Income, says he's satisfied with the fund as an investment but objects to having to accept a discounted price if and when he decides to sell. The fund's shares, which trade on the New York Stock Exchange, recently fetched about 13% less than the pro-rata value of the bonds held.

The fund's directors had recom- mended that shareholders vote down the proposal. They argued that converting to an open-end format could boost operating expenses, trigger capital gains distributions and make it harder to manage the fund's foreign bonds. They also noted that the shares never again would trade at a premium price if the proposal carried.

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