Comparison of Closed-end Funds to Similar Exchange Traded Funds: Effects

Barnhart and Rosenstein compared closed-end funds (CEFs) to exchange-traded funds (ETFs) with particular attention to discounts/premiums from underlying assets. Both CEFs and ETFs trade intraday like common stocks. 

The authors found that introducing an ETF that covers the same underlying assets of an existing CEF creates a discount in the CEF and reduces the volume of trading in the CEF. Their Table 1 tabulated the results from comparing 71 CEFs impacted by similarly designed ETFs. These results showed a decline for the CEFs relative to the underlying assets causing an existing discount to widen or a premium to decline. 

This study over the entire sample indicated on average a more than 6% decline after one month of the ratio to similar ETFs, and was found to be statistically significant. They studied across a universe of CEFs. The three major categories were: international equity, U.S. equity, and U.S. taxable bonds. 

The effect was strongest among the international equity CEFs, but was exhibited in the other two categories as well when analyzed over a year. The authors argue that the widening discounts are partially explained by the segmentation (especially in the international equity) found within the CEFs and their competing ETFs. 

Their regression analysis showed abnormal discounts and relative volumes are related to how close a substitute a new ETF is for the existing CEF. Each product has been designed around a structure of specific bundles of assets, and in the case of the ETFs they are keyed to indexes; whereas the CEFs contain set portfolios of assets that remain closed.

Source: Barnhart, S. W., & Rosenstein, S. (2010). Exchange-Traded Fund Introductions and Closed-End Discounts and Volume. The Financial Review, 45, 973-994.