Monday, August 17, 2009

Closed-end funds, Part II

Resuming my line of thought from yesterday....

Stephen Ross, in Neoclassical Finance, explains that behvioral economists make an example of closed-end funds, with their "visible and disturbing characteristic" that they routinely sell at significant discounts from their net asset values. this is a "seeming insult to rationality and the NA principle [No Arbitrage -- which in turn is crucial to neoclassical finance] that we will examine."

But in Ross' view, the customary discount can be explained as the result of (a) agency costs, in particular management fees, (b) the asymmetry of information among investors as to whether management has the ability to add value, and (c) the fact that arbitraging betweren NAV and the stock price is by no means costless "and is, in fact, widely recognized to be problematic." He gives a symbolic representation of that explanation that need not be reproduced here.

In my view, Ross uses this test case to score some solid blows aganst the behavioralists' presumption that irrational sentiments explain the prices of securities and their derivatives. And it is because he uses it as a test case that I have ever since had an eye on Karpus, and those funds that do engage in the sort of arbitrage that Ross described as "problematic."

Yesterday I noted that Karpus and Bulldog are both stirring things up at the Insured Municipal Income Fund Inc. Today I would like to add only that Karpus has another fight on its hands.

Last month Brett Gardner, portfolio manager at Karpus, filed a letter with the SEC that he had apparently also sent to the Putnam Funds board. He said that the board was misleading shareholders on the question of the merger of two ofits closed funds into one, and the opening of that one. The opening, of course, is a clssic discount-abolishing measure.

I believe Putnam has a meeting scheduled for November. We'll see how it shakes out.

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