UK closed-end fund discount

Minio Paluello, Carolina (1998) UK closed-end fund discount. Doctoral thesis, University of London: London Business School.

Abstract

A closed-end fund, referred to as an investment trust in the UK, is a collective investment company that typically holds other publicly traded securities. These funds are characterized by one of the most puzzling anomalies in finance - the existence and behaviour of the discount to net asset value (NAy). This study attempts to describe and characterise the discount on UK closed-end funds. First we describe the industry and extensively review the literature on closed-end fund discounts. Second, we revisit one of the traditional theories of the discount - managerial performance - which claims that discounts reflect the perception of management ability to outperform relative to a passive portfolio. We define the value added by active management using two methodologies - Gruber's (1996) unconstrained multi-index regression and Sharpe's (1992) returns-based style analysis regression'. We show that discounts weakly reflect past performance, but do not seem to predict future managerial performance. Analysis of the time-series behaviour of closed-end fund discounts shows that discounts are highly autocorrelated in their levels but not in their first differences. Nevertheless, we find weak evidence of price reversal. We also show that discounts have a tendency to revert to their mean and fluctuate around it within a certain range. Furthermore, there is strong evidence of discounts moving together. An attempt is made to explain at least part of the largely idiosyncratic movements in the discount. Our model of the discount generating process measures the sensitivity of the changes in the discount to factors that measure the influence of the market, size, sentiment, mean-reversion, manager, past performance and reversal. We find that these seven factors explain, on average, 35 percent of monthly changes in the discount. Finally, we investigate the behaviour of UK closed-end funds at the time of the IPO, of seasoned equity offerings (rights and "C" share issues) and of open-ending. We find that (i) share prices tend to decline after the IPO, (ii) funds tend to disappear after periods of poor NAV performance and (iii) funds with good past share price and NAV performance tend to have rights and "C" share issues.

References
M.J. Gruber (1996), Another Puzzle: The Growth in Actively Managed Mutual Funds. Journal of Finance

W.F. Sharpe (1992), Asset Allocation: Management Style and Performance Measurement. Journal of Portfolio Management.