ETFs vs. CEFs (Closed End Funds)—What’s The Difference?

Ulli Uncategorized 3 Comments

With the explosion of Exchange Traded Funds (ETFs) over the past few years, there’s still some confusion among investors between the difference of buying an ETF or his close cousin, the CEF (Closed End Fund).

Unlike mutual funds, both of them are traded on stock exchanges as opposed to an open ended mutual fund, which is purchased directly from a fund company.

The main difference between the two is that ETFs represent mostly indexes while many CEFs have actively managed portfolios that allow the fund manager to adjust to changing market conditions. The fund manager’s job, in comparison to handling traditional open ended mutual funds, is made a lot easier.

How?

Since investors in traditional mutual funds can buy and sell shares at anytime, the manager has to deal with the constant inflow and outflow of money and liquidate or add to his positions during market conditions that may not be most favorable.

This can create even more of a problem in certain international markets that lack the liquidity which we are used to seeing here in the States.

With CEFs, however, the fund manager is not concerned with these issues. Once the original public offering of a closed end fund is completed, all further transactions are being handled on the secondary market. The fund manager knows exactly the size of the fund and how much money he has to work with. So he can focus on what he does best: Manage a fixed size fund to achieve the objectives as outlined in the prospectus.

Another advantage of CEFs is that they “can” trade at a discount (or at a premium) to the value of the underlying assets. This is not necessarily a reflection of performance but simply a function of supply and demand. But, before you rush out and buy any CEF that trades at a discount, be advised that they can stay at a discount for a long time.

It’s kind of like buying a new car at a discount from list price, because this model is out of favor. However, the quality or performance of that car is not impacted by the discount.

CEFs offer an advantage especially when investing internationally. As you may have found out, many conventional international mutual funds carry a sales load of some 5.75% and some are run by well know managers such as Mark Mobius from Templeton. While I personally don’t subscribe to the theory of picking a fund based on its manager, there are many investors who do.

CEFs can help you invest into funds run by such seasoned managers. For example TDF and EMF are 2 such funds that are run by Mobius and it only costs you a trading fee to buy into them (Neither I nor my clients have any holdings in those funds).

With all of these benefits, are there any disadvantages to using CEFs vs. ETFs?

First, both should be used when appropriate. Second, while ETFs have low annual fees of around 0.4%, expect to pay around 1.5% for CEFs, just like regular mutual funds. They are actively managed and therefore carry higher annual expense ratios.

Both, ETFs and CEFs have a place in an investor’s portfolio. Given the all too stringent holding and trading requirements of conventional mutual funds, ETFS and CEFS will gain more favor as investors understand and learn how to use them as a viable alternative.

No Load Fund/ETF Tracker updated through 2/2/2007

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The markets rallied sharply with Fed policy remaining accommodative. Our Trend Tracking Index (TTI) for domestic funds moved +5.37 % above its long-term trend line (red) as the chart below shows:



The international index still remains stronger and currently sits +9.88% above its own trend line, as you can see below:



For more details, please see the above link.

The Real Estate Confusion

Ulli Uncategorized 4 Comments

Lately, a frequently asked question in my advisor practice has been related to real estate.

Last week, the government reported that new homes sales fell 17% last year — the worst decline in 16 years.

However, sector real estate funds/ETfs gained on the day. In fact, the leader of the sector listings in my newsletter, based on a 4wk sorting, was real estate, as you can see from the following table:


The reason for that apparent discrepancy is that most readers look at all real estate as being the same, which is not the case. When you hear reports about a real estate recession or a downturn, so far this has been strictly related to residential property.

All sector real estate mutual funds/ETFs invest in REIT’s, which in turn are exposed to commercial and industrial properties and not residential ones. With the economy humming along just fine, based on the performance of the stock market, commercial real estate has rallied sharply due to higher demand and other factors.

Will this go on forever? Of course not. That’s why, for all of our positions, we have trailing stop loss points set up to protect ourselves from the downside whenever this market reverses its trend.

This may not be in the near future, but you have to be ready to act whenever the facts change.

No Load Fund/ETF Tracker updated through 1/25/2007

Ulli Uncategorized Contact

The latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The tug-of-war between bulls and bears continued this week. Our Trend Tracking Index (TTI) for domestic funds remains +4.06% above its long-term trend line (red) as the chart below shows:



The international index still remains stronger and currently sits +8.30% above its own trend line, as you can see below:

For more details, please see the above link.

The Ignorance Game: Index Funds vs. Mutual Funds

Ulli Uncategorized 3 Comments

The year 2006 has barely come to an end and the battle goes on. Which one has been the better investment? Index funds or actively managed mutual funds?

Standard and Poor’s reported that the S + P 500 index outperformed 69% of actively managed large-cap mutual funds in 2006. Additionally, the S + P SmallCap 600 outperformed almost 64% of actively managed small-cap mutual funds.

The story goes on to say that over the past five years, the S + P 500 index has beaten 71% of managed large-cap funds. The S + P SmallCap 600 has beaten 78% of managed small-cap funds in the same period.

I have no problem with these numbers, since in my advisor practice we use index funds/ETFs as well whenever they make sense in any given economic environment.

However, there is an ignorant part of that story that totally neglects to point out that markets don’t always go up. What will happen during a bear market?

A casual or inexperienced reader of the above figures could easily interpret them as an argument that index funds are the investment for all seasons. This is not the case. When a bear market strikes, such as the during the period of late 2000 to early 2003, index funds, as well as actively managed mutual funds, will go down sharply.

Some of them were pushed to such low levels that it took a Buy + Hold investor over 5 years just to get back to a break even point. What difference does it make that an index fund may be a better investment when you can lose just as much with it when the bear rears its ugly head?

If a bear market has the potential to devastate an investor’s portfolio, shouldn’t the primary emphasis of investing be to try to avoid that scenario, rather then some chest pounding over a couple of percentage points?

That’s my view, what’s yours?

No Load Fund/ETF Tracker updated through 1/19/2007

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Despite sloppy sideways action in the market the upward bias remains. Our Trend Tracking Index (TTI) for domestic funds remains +4.91% above its long-term trend line (red) as the chart below shows:


The international index still remains stronger and currently sits +9.24% above its own trend line, as you can see below:

For more details, please see the above link.