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Q

I was surprised by your Bond Forum item (“Disappointed in closed-end bond fund”, 3/3/08). I believe your statement that closed-end funds are experiencing a wave of redemptions is not quite accurate. The basic premise of a closed-end fund is a finite number of shares and to trade in the market at a price that is either connected or disconnected to the net asset value of the fund. Should someone wish to sell their share, they do it in the marketplace. At times, there may be more sellers than buyers or buyers than sellers, which can cause the discount to widen or narrow to the net asset value. As a registered investment advisor who specializes in the closed-end format, we have found that our selection of closed-end funds can and does beat benchmark returns over longer periods of time or an interest rate cycle. Diversification is a key ingredient that closed-end funds afford the individual investor along with professional management. Purchasing a fund at a discount further adds to current returns. Tax efficiencies are more profound that individual bonds. The auction rate preferred shares used for leverage have been involved in failed auctions, which can create a higher cost of leverage for the funds, but is starting to stabilize according to historical averages.

A

James A. Klotz responds:

We agree that we could have phrased the quote in question a little better, but we see the difference as semantical rather than fundamental.

The decline in closed-end fund prices, which we blamed on redemptions, is really caused, as you say, by “more sellers than buyers,” which in the days before listing these funds on an exchange would have been called “more redemptions than sales.”

Either way, it reflects investors exiting these funds.

Although you seem quite sanguine regarding failed auctions, we are not sure that investors who can’t get their money out of these preferred shares take solace in the fact that these funds are “starting to stabilize according to historical averages.” In fact, the flood of e-mails we have received reflect quite a different attitude.

Right or wrong, many investors feel they were misled by their brokers and financial advisors, who promoted these preferred shares as “cash or cash equivalents.”

We understand that a number of closed end funds are arranging financing to correct this problem. However, the trust that was lost will not be easily regained.

We are not aware of the “profound” tax advantages that closed-end muni funds enjoy over individual municipal bonds, but we would be pleased to hear more on this subject.