In part 1 of our commentary, we discussed the current Fundamental Gravity of our “Reflation&rs...
What’s Your Pick: ETFs or Closed-end Funds?
08/16/2007 12:00 am EST
ETF expert Carlton Delfeld, president of Chartwell Partners Inc., shows investors how to evaluate the choice between exchange traded funds and closed-end funds…
Both exchange traded funds and closed-end funds trade on exchanges like a stock and can be bought and sold at any time during the trading day.
But there are several important differences. Closed-ended funds are actively managed and do not track an index, creating tax implications and leading to higher fees. And because a fixed amount of shares are on the market, demand results in closed-ended funds trading at a premium or discount to the fund's net asset value—a variance that can be substantial.
Some closed-end funds that I sometimes use as proxies for country ETFs in our seven model ETF portfolios are: Jardine Fleming China Region, (NYSE: JFC), Malaysia Fund, (NYSE: MF), Thai Fund (AMEX: TF), Morgan Stanley China A Share (NYSE: CAF), Morgan Stanley India Fund (NYSE: IIF).
It is important to look at the history of premiums or discounts and see if there is a pattern. Sometimes the closed-ended country fund offers investors a more balanced pattern of company weighting and more upside potential.
Let’s compare the Morgan Stanley closed-ended India fund and the Barclay’s India exchange traded note that attempts to track the MSCI India Total Return Index.
Here are their top five holdings:
Barclay’s India ETN (NYSE: INP):
Infosys Technologies 13.7%
Reliance Industries 13.1%
ICICI Bank 8.1%
Housing Development Finance 4.3%
Reliance Communications 4.0%
Morgan Stanley India closed-ended fund (NYSE: IIF):
Infosys Technologies 8.9%
Bharti Airtel 6.8%
ICICI Bank 5.9%
ABB Ltd. 5.7%
Bharat Heavy Electricals 4.8%
INP has roughly 35% exposure to its top three names and 43% to its top five companies, while IIF has 21.6% and 32%, respectively. In addition, it has three companies in its top five that are not in the market cap-weighted MSCI India index.
In the last year, investing heavily in the largest companies has worked rather well. Morgan Stanley found that over the twelve months through May, the SENSEX index increased 11% in Rupee terms, but an incredible 130% of this return was due to the performance of the top five companies in the index. The median return of 2,400 companies listed on the exchange was negative 17%.
But going forward, this pattern of performance is unlikely and I would rather take a bit of a broader approach especially since these top five companies appear to be a bit pricey. The advantage appears to go to the closed-ended fund.
As for the discount/premium issue—the closed-ended fund has been trading at a premium until February and is now at a 13% discount to net asset value. The nice sale price reinforces leaning to the closed-ended India fund option.
Always take some time to look “inside the hood” of the ETF you are considering and for country-specific ETFs, do the same for its cousin. It may be well worth the somewhat higher fees.
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