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Closed-end Funds See Banner Year

Closed-end funds are on pace to close out a record year of asset raising.

So far this year, 42 new closed-end funds have held their first public offering and have collectively raised a record $22 billion, according to Lipper. Another handful have come to market within the last two weeks and will up that ante even further, analysts predict.

Strictly by the numbers, however, 2003 wasn't a record year for the quantity of closed-end funds that emerged. In 2002, a total of 78 closed-end funds were born, nearly 60% more than those launched this year. And collectively, those funds raised about $20 billion, said Jeff Margolin, vice president and senior closed-end fund analyst with Ryan Beck & Co. brokerage, New York. But individual closed-end funds have attracted a tsunami of assets this year, with five funds each attracting $1 billion or more.

Topping the 2003 list is the all-time record $1.95 billion raised by the Eaton Vance Limited Duration Income Fund, which debuted May 29, 2003, closely followed by the Nuveen Convertible Preferred Income Fund 2, which came to market one month later in June and raised $1.93 billion. Three months earlier, Nuveen had launched its original convertible preferred income fund and raised a respectable $1.26 billion.

Eaton Vance takes top honors for raising the largest asset pool ever by one single closed-end fund, a record that previously belonged to MFS. The firm had held the bragging rights to the $1.86 billion it raised when it launched the MFS Intermediate Income Fund in March of 1988. Van Kampen was the first complex to give MFS a run for its money when it raised a whopping $1.80 billion with the debut of the Van Kampen Senior Income Fund in June of 1998.

A 17% Rise

According to the Investment Company Institute, as of Sept. 30, there were a total of 575 closed-end funds trading, 449 of which are fixed-income funds and 126 of which invest in equities. In contrast, at year-end 2001, the closed-end fund universe consisted of 493 funds.

Fixed income closed-end funds again were the overriding product of choice to launch in 2003, as they were in 2002. More than 90% of the funds launched this year are income-oriented funds, fueled by a combination of low interest rates, and the need for income from many older and retired investors, said Don Cassidy, senior research analyst with Lipper.

One trend among closed-end funds this year has been the launch of many blended-style funds combining two or more types of income-producing securities in one fund.

But there's also been a hint of a move back to equity-oriented funds, analysts said. This past summer, two new pure equity funds debuted from First Trust, after a dearth of new closed-end equity funds over the last several years.

While the closed-end marketplace may be warming to the idea of new equity offerings, fixed-income funds that use leverage to enhance the yield a bit are getting a chilly reception from some analysts.

There is a great incentive for closed-end fund sponsors to employ leverage because they can charge their management fee on the higher asset base. But with interest rates at record lows, and expected to ratchet up next year, leveraged funds may be in for a bumpy ride. Rising rates can wreak havoc on a fixed-income fund's portfolio, Cassidy said. Last summer Lipper raised caution flags on leveraged funds.

Ditto at Ryan Beck. "Now we're more cautious toward leveraged closed-end funds," said Margolin, who notes that up until September, his firm had been recommending closed-end leveraged municipal bond funds to brokers, but several weeks ago lowered their ratings for the next 12 to 24 months. "Higher leveraged funds have the potential to get hit pretty hard and harder than non-leveraged funds [when interest rates rise]," he said. Although, over the longer term, a leveraged strategy can have advantages, he added.

Moody's Investors Service of New York isn't in total agreement. In a report issued last week, Moody's analyst Barbara Percia noted that although risk is always present, leverage is likely to add value in 2004 despite rising interest rates. Moody's believes that managers are employing more risk management tools such as investing in U.S. Treasury futures and interest rate swaps to hedge fund borrowing costs. Consequently, the impact of rising rates will likely be lessened than in other historical periods of rising rates.

And the 2004 Winner Is . . .

If interest rates do start climbing next year, the big winners could be the small universe of floating rate, senior bank loan funds which gained popularity in the 90s, but have struggled over the past few years, analysts predict (see MME 4/28/03). While floating rate funds have rebounded and are up an average of 28% this year, most are leveraged, said Margolin. But leverage isn't a negative for bank loan funds because these loans have their rates periodically reset to current interest rate levels. As rates rise, interest paid on the securities rise.

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