On Friday, the first ETF consisting solely of closed-end funds started trading. It is named the “PowerShares CEF Income Composite Portfolio” (PCEF), is managed by Invesco PowerShares and is based on the S-Network Composite Closed-End Fund Index.
The index is rebalanced quarterly and uses a set of filters to screen the closed-end fund universe. It includes CEFs in three income categories:
- Taxable investment grade fixed-income.
- Taxable high yield fixed-income.
- Equity option writing.
Some additional filters are:
- All CEFs in the index must trade on a recognized North American stock exchange that provides a last closing price.
- Minimum market capitalization of $100 million.
- Average daily trading volume of more than $500,000 a day for the three months prior to the rebalancing date.
- The CEF must trade at less than a 20% premium to NAV.
- Total expense ratio less than 2% as of most recent filing date.
70 closed-end funds passed the above filters and are now in the index. Here is a link to the current CEFs in the portfolio.
The primary weighting for the index is net assets. Adjustments are made to try to take advantage of inefficiencies in the closed-end fund market by assigning greater weightings to CEFs that are trading at discounts to NAV:
|Weight Increases for Funds Trading at a Discount to NAV|
|Discount > 6% = 30% Increase in Net Assets|
|3%> Discount > 6% = 20% Increase in Net Assets|
|0%> Discount > 3% = 10% Increase in Net Assets|
|Weight Decreases for Funds Trading at a Premium to NAV|
|Premium > 6% = 30% Decrease in Net Assets|
|3% > Premium > 6% = 20% Decrease in Net Assets|
|0% > Premium > 3% = 10% Decrease in Net Assets|
The expense ratio for PCEF is 0.50% (not including expenses of the underlying CEFs). This compares favorably to its competitors FOF and GCE which both have expense ratios of 0.95%. (Note: FOF is a closed-end fund of CEFs. GCE is an ETN of CEFs).
The attempt to capture CEF inefficiencies is interesting, but fairly limited, since the rebalancing will only occur quarterly. Some of the best inefficiencies for CEFs occur briefly when a large institution has to “dump” a position. PCEF will miss these opportunities. There is also a concern that more nimble CEF traders may try to “front-run” the changes in PCEF every quarter. The PCEF managers have tried to minimize this possibility by using net assets as the primary weighting and minimum trading volume as a filter.
Full Disclosure: No position in PCEF.