As interest rates look to remain low for the foreseeable future, investors are searching for income, and rediscovering an old instrument: closed end funds.
The normally sleepy market for closed end funds has picked up in recent years, with 15 new closed end funds raising a total of $6.8bn from the start of this year through August, according to Cerulli Associates. That pace is set to surpass the 17 new funds that came on the scene in all of last year. For comparison, 2008 saw just two closed end funds launch.
Why so much investor enthusiasm now?
Unlike their colleagues at mutual funds, closed end fund managers generally have more freedom to use leverage to boost returns. With the Fed's outlook for keeping rates low until 2014, the future looks rosy for the majority of closed end fund managers who use leverage to boost yields. One portfolio manager told Cerulli analysts that investors feel more comfortable investing in leveraged funds in periods of low interest rates.
What's more, closed end funds tend to trade at a discount to the net asset value of the portfolio. Put the two trends together and you have an attractive environment for closed end funds. Cerulli believes that the vehicle will likely move from strength to strength in the coming years as more Baby Boomers retire, increasing the national appetite for income.
So given the thirst for yield, it's no surprise the most popular offerings so far this year have been in fixed income. Global bond and corporate high yield closed end strategies have been the most successful in raising assets. One big winner was the PIMCO Dynamic Income Fund, which snared $971m at its launch in May.
Product developers are extremely focused on the entire area now because low yields are forcing advisors to beat the bushes for ways to generate income for clients, according to Cindy Zarker, director of the asset management practice at Cerulli. She said one firm told her they were "definitely" going to create more closed end funds.
Interestingly, because of their structure, closed end funds have another characteristic that's in vogue now: no daily liquidity requirements. Because closed end fund shares are traded on the market, not created by the fund manager when new investors want to buy in, closed end managers can stay fully invested all the time. So, these funds are ideal vehicles for many alternative strategies. However, at the moment, just 7.5% of the closed end fund assets in 2011 were invested in alternative strategies. In large part this is because these funds are traditionally sold to a conservative clientele who is primarily concerned with income.
"At the end of the day, the closed end market is very much driven by sales, and that's what the advisors who sell them think of them for," Zarker said. Nevertheless, she thinks alternative strategies will gain ground in the asset class, "because it is such a perfect vehicle." When she asked product developers where they were concentrating their efforts, they told her their first priority was income, and second was alternatives.