Date
4 December 2016
Cheap money has prompted many people to invest with borrowed money, contributing to excess demand for closed-end funds and causing some of them to trade at a big premium to the underlying asset value. Photo: Reuters
Cheap money has prompted many people to invest with borrowed money, contributing to excess demand for closed-end funds and causing some of them to trade at a big premium to the underlying asset value. Photo: Reuters

Huge premium of closed end funds is a warning signal

Extremely low or negative interest rates have fueled excessive borrowing over the past few years, and some of those borrowed funds have been invested in bonds, real estate investment trusts and equities.

But since the G20 meeting earlier this year, major central banks seem to have reached a consensus that monetary easing is not going to revive the global economy.

The end of easy money could trigger a huge wave of deleveraging and the collapse of asset prices.

Take a look at the huge premium of some closed-end funds listed in the United States, and you will realize how crazy the market has become.

Of the 535 closed-end funds, which have a fixed number of units, 80 trade at a premium to their underlying asset value.

Gabelli Go Anywhere Trust Combo, a newly issued closed-end fund, enjoys a 45 percent premium,regardless of the fact that the fund has not even started to invest.

Some closed-end bond funds and high-yield funds command a premium as high as 70 percent.

That’s because demand for closed-end funds when the market is strong could outstrip the limited supply.

But if sentiment turns sour, supply could overwhelm demand, and that will lead to a discount.

When the gap – whether a premium or a discount – becomes huge, the market is in a very abnormal situation, which is what we are seeing at the moment.

We have an example in Hong Kong, too. HSBC launched the HSBC China Dragon Fund (00820.HK) in July 2007 at HK$10 per unit.

The unit price of the exchange-traded fund soon spiked to over 70 percent as investors flocked into the fund amid an overheating market.

But since October that year, the fund price started to slide, and at one point, it traded at a discount of 37 percent.

It still offers a discount of 20 percent at present.

The fund’s price closed at HK$8.8 on Wednesday, with a corresponding asset value of HK$11.19.

That means investors who have bought and held the fund for nine years are still suffering from a loss.

This article appeared in the Hong Kong Economic Journal on Oct. 27.

Translation by Julie Zhu

[Chinese version 中文版]

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RT/CG

Founder and Managing Director of Pegasus Fund Managers Ltd.

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