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Across My Desk: Closed-end Funds

Closed-end funds provide one way for folks to invest into a basket of securities at a per share price that trades like stocks do---all day long on the major exchanges. While there's more to these investments then that singular price implies, you may also buy a closed-end fund as an IPO. But, as the following Lipper Insight Report shows, buyer beware.

What follows is the Executive Summary of the latest Lipper Fund Industry Insight Report titled, " Buying A Closed-End Fund InitialPublic Offering: Caveat Emptor!"

The study looks at the aftermarket performance of IPOs brought to marketthis year. Since closed-end funds typically have no preexisting assets orproprietary rights, there is little information asymmetry about their assetvaluation; their underlying asset is a portfolio of marketable securitiesand cash. Consequently, they should exhibit little over/underpricing.

Lipper Researach findings indicate that the typical closed-end IPO is extremely unlikelyto rise sharply soon after its inception because its portfolio consistsprimarily of cash. By the same token, it is also unlikely to experiencesignificant declines immediately following the IPO.

That said, these IPOs are more likely to experience losses in each of the first three months following its launch.

Bottom line: The typical pricing pattern of a closed-end fund IPO tends to seelittle price movement during the first month. Then, Ęsharper declinesin the second and third months.

As for IPO premium prices (premium prices happen when the per share price of the closed-end fund is selling for more than the basket of securities it holds) tend to disappear and turn into discounts by the end of the second and third months. Those discounts tend to widen and become persistent during the third month.

The average negative 2004 post-IPO returns amounted to 1.4% duringthe first month, 5.8% during the second month, and 3.1% during the thirdmonth. The overall accumulated three-month loss for the typical closed-endfund was 10.6%.

My thoughts? While the IPO market may be a hot one for some equities, I'm with Lipper so look carefully before leaping into the IPO closed-end fund arena.

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