Closed-End Fund Pricing: Theories and Evidence (Innovations in Financial Markets and Institutions)
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Closed-End Fund Pricing: Theories and Evidence - Seth Anderson, Jeffery A. Born - Google Книги
Closed-End Investment Companies CEICs have experienced a significant revival of interest, both as investment vehicles and as the subject of academic research, over the past decade. This academic research has focused on the nature of closed-end funds' discounts and premiums and on the share price behavior of these firms. The first book by the authors, "Closed-End Investment Companies: Issues and Answers," addresses closed-end fund academic articles published prior to This second book addresses those articles that have appeared since that time.
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This contrasts with actively managed funds, which seek to earn higher returns than their chosen benchmark through discretionary security selection or trading in anticipation of market turning points. Doing so generates trading costs and requires compensation to active managers and investment in relevant information, which go hand in hand with higher fees. Aside from the issue of the potential benefits and costs for individual investors, rapid growth of passively managed portfolios has generated debate about their possible impact on securities markets.
One concern is that the mechanical investment rules of passive investing may give rise to distortions in the pricing of individual securities.
At the aggregate level, there is also the question of whether it might add to destabilising price dynamics by amplifying investors' trading patterns. This special feature provides a conceptual and empirical discussion of these issues. A key observation is that, despite their rapid growth, passive funds account for a relatively small fraction of outstanding securities. Even so, the available empirical evidence suggests that portfolio-wide trading of passive funds can still contribute to correlation across individual security prices.
The mechanical way that passive funds manage their portfolios implies that their impact on aggregate security price dynamics will depend mostly on how end investors behave. In this respect, we observe that investors in index mutual funds exerted a stabilising influence in recent periods of market stress relative to those using active mutual funds, while flows in and out of ETFs were relatively volatile. The remainder of this feature is organised as follows. The first section provides an overview of the growth in passive funds across asset classes and countries.
The second outlines the theoretical grounds for passive investing, and the third discusses factors behind its recent growth. The fourth considers the implications of greater passive investing for security prices and issuers, while the fifth examines the impact on aggregate fund flows and market price dynamics. Passive fund assets have expanded rapidly over recent years and now represent a significant portion of the global investment fund universe.
Passive or index mutual funds, the traditional passive portfolio product, grew sharply over this period. ETFs, which allow intraday trading of shares in passive portfolios on a secondary market, grew even faster Box B. Growth in passive funds has been rapid for both equity and bond asset classes centre panel. The rising popularity of passive equity funds has displaced investment in their active counterparts, which experienced outflows over the past decade right-hand panel. Net outflows from active bond funds were concentrated in and - periods of bond market turbulence. Most of the remaining passive funds specialise in commodities.
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Despite the rapid growth of passive bond funds, the majority of passive portfolios remain focused on equities. To some degree, this reflects the greater liquidity and exchange-traded nature of equities. In addition, constructing and tracking indices of equities is easier because they are perpetual securities, while the high correlation of interest rates may make holding broad market index bond portfolios less attractive Fender Across countries, passive funds have gained most prominence in US equities.
Although starting from a much lower base, passive funds have gained even more traction among Japanese equity funds, supported by the Bank of Japan's ETF purchases and the Government Pension Investment Fund's increased allocation towards equities over recent years. While passive funds have made substantial inroads into the universe of investment vehicles available to end investors, their holdings as a share of total outstanding securities remain at a relatively low level due to the sizeable holdings of other non-fund investors Table 1.
Using assets managed by index tracking funds is a simple approach to measuring the extent of passive investing, but it is not without shortcomings. In practice, the distinction between passive and active fund strategies is fuzzy. The risk of outflows if they underperform their benchmark leads many active funds to avoid portfolios that deviate substantially from those of the market index.
Cremers et al find that in many countries the share of "closet indexing" where weights of securities in equity fund portfolios are not substantially different from those of the benchmark is more or less the same as that of "explicit indexing", if not higher. Closet indexing is also prevalent among actively managed bond funds, particularly those investing in EMEs Miyajima and Shim Furthermore, other investors, such as pension funds and insurance companies, may implement passive investment strategies in their portfolios managed in-house or through investment vehicles other than mutual funds and ETFs.
The rise of "smart beta" ETFs further blurs the distinction between passive and active fund management. Rather than track traditional market value-weighted indices, smart beta ETFs implement factor-weighting index strategies such as those for value, volatility and dividend yield , the construction of which can be considered active in nature Blackrock In sum, ascertaining the true extent of passive investing is challenging.
Nonetheless, it seems clear that over recent years there has been a substantial shift towards passive portfolio management globally. The end users' choice of investment vehicle depends on not only the track record of the fund manager but also how the manager's style accords with their preferences and risk appetite.
There are several general considerations for individual investors in deciding whether or not to adopt a passive investment strategy market-wide considerations are discussed further below.
The implications of passive investing for securities markets
From a theoretical perspective, the rationale for individual investors adopting a passive investment strategy is grounded in the notion of efficient markets. This theory holds that security prices rapidly incorporate all available information, implying that excess future returns are not predictable. Limited scope for systematic outperformance raises doubt about the rationale of incurring management fees in excess of those necessary to maintain a diversified market portfolio.
Even if one rejects the notion of market efficiency and thus the inability of managers to produce above-market returns over time , passive investing can still be considered an optimal strategy to the extent that outperformance of the market benchmark is a "zero sum game" Sharpe , Malkiel Since passive investors' average return before costs should, by construction, equal the market return, the average return across all active investors must also equal the market return. Given that active investors are attempting to beat the market, any gains for some of these investors must be offset by the losses of others.
Thus, after trading costs, the average return for active investors will be less than for passive ones. In principle, investors could earn superior returns by selecting those active funds that outperform. But identifying such funds can be difficult in practice because it requires ex ante information about the incentives and skill of a manager.
Adopting a strict index-based investment strategy therefore circumvents the main asymmetric information and agency problems arising from delegating authority for investment decisions to a fund manager Vayanos and Woolley Notwithstanding the above arguments, there may still be a strong theoretical case for active management. First, informed active managers can earn above-market returns to the extent that the investor universe also includes active but uninformed investors whose aggregate portfolio underperforms the market.
Second, while the zero sum game argument holds for a constant market portfolio, in reality passive fund managers must trade albeit not frequently to manage investor inflows and outflows and because indices themselves are not static Pedersen This means that, on average, informed active investors could outperform the benchmark by taking advantage of passive managers' predictable trading patterns, such as by trading in anticipation of adjustment to index membership or ahead of initial public offerings.
Various factors have contributed to the growing investor preference for passive funds in recent years. A key one has been the better performance record of passive funds over actively managed funds. After fees and expenses, most active equity funds have failed to outperform the market benchmark in recent years Graph 2 , left-hand panel. Moreover, at least in major markets, funds that outperformed their benchmark have not done so consistently. By and large, the findings of the empirical literature accord with recent experience; after fees and expenses, the average active equity fund underperforms the market portfolio over long horizons eg Jenson , Carhart , Fama and French , Busse et al Although the literature is much less extensive, there are comparable findings of underperformance by active bond funds, on average, after adjusting for the riskiness of fund portfolios relative to the market benchmark Blake et al , Cici and Gibson The recent popularity of lower-cost passive funds has been supported by structural shifts in the financial advisory industry.
Regulators' greater focus on fee transparency has also played a role in some jurisdictions.
The bulk of money flowing into passive funds over recent years has been directed to the largest fund managers, which tend to offer the lowest-cost funds. This pattern of inflows can set in motion scale economies that help compress fees Graph 2 , right-hand panel.
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It also enables greater netting of inflows and outflows, as well as the negotiation of more favourable trading fees from brokers, thus reducing trading costs. Greater use of information and computational technology is another factor underlying the development of the index industry and the rise of passive investing. There has been a marked expansion in the range of indices beyond traditional broad market benchmarks, opening up investment and diversification opportunities previously inaccessible to many investors.
Lastly, the recent period of low volatility and associated high correlations within asset classes might have reduced the rewards to active security selection. The discussion in the previous two sections provided an individual-investor perspective on the rise of passive investing. The adoption of passive strategies by an increasing share of investors also has implications for security prices and issuers.
Passive fund investment decisions are made at the portfolio level and not at the level of individual securities. Passive fund managers and investors naturally place emphasis on systematic or common factors affecting portfolio returns, such as expectations about monetary policy, inflation and other macroeconomic factors. By contrast, passive portfolio managers have scant interest in the idiosyncratic attributes of individual securities in an index. They do not devote resources to seeking out and using security-specific information relevant for valuing individual securities.
In effect, they free-ride on the efforts of active investors in this regard. Hence, an increase in the share of passive portfolios might reduce the amount of information embedded in prices, and contribute to pricing inefficiency and the misallocation of capital. An increase in passively managed portfolios could also affect the pricing of securities through greater portfolio-wide trading in the market.
Passive managers buy and sell the entire basket of index constituents in response to fund inflows and outflows. This trading pattern can induce higher co-movement in the prices of the constituents of the index.