Converting Closed-End Funds to ETFs: Has the Trend Begun?

Update! Last month I commented on some developments here in Canada that saw a closed end fund converted into an ETF. I asked if that was the beginning of a trend.

Maybe not a massive trend, but I now see that First Trust is doing the same with one of their closed end funds. It’s the First Trust Value Line® 100 Fund (FVL) and here’s the press release discussing the conversion. First Trust must really be commended for providing A LOT of information on their funds online.

Unlike the Claymore conversion in Canada that has a truly active manager with a classic active management mandate, the First Trust closed end fund seems to fit the model of other rules-based “quasi-active” ETFs such as their own new AlphaDex funds as well as the IntelliDex and fundamental weighted (FTSE-RAFI (PRF)) funds both from PowerShares.

The question is if and when we’ll see more traditional closed end funds converting into exchange traded funds? Furthermore, if by doing so, would we hopefully see a minimal spread (premium/discount) between the funds’ market price and the underlying net asset value. I’m sure that many investors who have exposures to the various country specific funds and thematic funds (infrastructure, for example) on the NYSE would be interested to see a structure, if possible, that would reduce, if not eliminate, this problem with closed end funds.

I’m fairly sure that a part three in this series will follow quite soon.

Comments

[Frank Li]

This is very interesting, because conversion to an ETF is probably a much faster way of closing any discount to NAV than, for example, doing a tender.

How about writing something about which CEFs trading at discounts to NAV are the most likely candidates to become ETFs, Richard???
:-)

[Richard Kang]

FL: Speculation on the markets is fine but speculation on future CEF-ETF conversions is beyond difficult and in my opinion a rather pointless exercise. Unless you have idea of some form of arbitrage strategy where you take a position in the CEF and a simultaneous offsetting position in the underlyilng basket (or other strategy) but I don't see how this conversion can be used for an opportunistic trader.

[Chamois16]

There seems to be a prevailing view here that discounts for closed-end funds are somehow undesirable. The discount is te natural investor offset to the fund's fees, adjusted for the liquidity of the CEF portfolio. Iow, plain vanilla equity CEF deserve a higher discount than bond or more sphisticated portfolio holdings such as syndicated loans and derivatives. The issue ought not be the discount, but the extent of excursions from it which imply CEF investor sentiment different from that of the broader market.

The prinicpal disadvantage of CEF is their low daily trading volumes, which limit their utility for larger investors. Otoh, there are many offsetting advantages, such as leverage, hugher yields and freedom from cash drag, which make CEF attractive to average retail investors.

The reasons why CEF managers would want to convert to ETF on a large scale are certainly not clear, nor is the rationale which might be persuasive to CEF investors.

[grinninbrit]

Yes, and if the problem were excessive discounts, that is less the case now than its ever been.. many funds are trading at premiums and even large premiums to NAV. Discounts are very low, especially if you look at this historically. Much less a compelling reason to convert than in the past.