What is a closed-end fund?
A closed-end fund (CEF) is set up as a company under the Companies Act and is generally listed on a stock exchange. It has a fixed number of shares outstanding and its capital is raised through an initial public offering like any other public offerings. The funds that it pools from shareholders are then invested according to the stated investment policy and objectives. These investments are managed by a fund manager. Investors who buy the shares of a CEF will become shareholders of the company. Like all other publicly traded securities, shares of a CEF are bought and sold in the open market. Its share price is determined by supply and demand in the marketplace.
Types of CEF
The different types of CEF include:
[i]. Diversified Equity Funds – These CEFs focus on common stocks. They usually consist of stocks issued by a broad mix of companies and diversified across industries, geographic regions and economic sectors. Some specialize in a particular asset class or investment style, such as large-cap, small-cap, growth stocks or value stocks. For example, Foreign and Colonial Investment Trust Plc, etc.
[ii]. Sector and Specialty Funds – These CEFs concentrate on stocks of a particular industry, such as banking, technologies, properties and others, or on specialized securities such as preferred stocks or convertible securities. For instance, Petroleum and Resources Corporation, Emerging Markets Telecommunications Fund Inc, Polar Capital Technology Trust Plc, etc.
[iii]. Single Country Funds – These CEFs focus on securities of a single country. Due to the impressive performance of emerging market equities in the early 1980s, closed-end ?country funds? became popular. A CEF investing in emerging market securities, which can be highly volatile and somewhat illiquid under adverse market conditions, has advantages over a unit trust fund, as a CEF is not forced to sell their portfolios to meet redemptions or to buy at high prices due to inflows of funds. The fund manager of a CEF can employ a long-term strategy and hold positions through the declines. Some of the examples of single country funds include, Malaysia Fund Inc, China Fund Inc, Germany Fund, etc.
[iv]. Regional Funds – Some CEFs focus on regions rather than individual countries. Fund managers play the role in deciding which country to invest in and how much to allocate to each country. Like all forms of foreign investments, there is an additional risk, which is currency risk. Examples of regional funds are the Asia Pacific Fund Inc, European Assets Plc, Pacific Horizon Plc, etc.
[v]. Global Funds – While regional funds focus on a particular region, global funds take a global perspective by investing in global markets. For example, World Trust Fund Plc, etc.
History of CEF
The history of CEFs dates back to the 19th Century even before the first unit trust funds came about. In the US, CEFs started in 1893, more than 30 years before the first open-end fund was formed. In the UK where CEFs are known as investment trusts, the first CEF, Foreign & Colonial Investment Trust Plc, was formed back in 1868, with the following objective:
“…….. to give the investor of moderate means the same advantages as the large capitalist in diminishing the risk of investing ………… by spreading the investment over a number of stocks.”
During the early days, many CEFs were created to invest in the New World, particularly to provide capital for the construction of US railroads. CEFs grew rapidly during the “Roaring Twenties”. Prior to the Great Crash of 1929, CEF assets totalled US$4.5 billion and accounted for a significant percentage of the total capitalization of the stock market. With the stock market roaring and everyone chasing instant riches, funds were easily manipulated. Due to pyramiding (funds buying other funds) and the extensive use of borrowings by fund managers, most of the CEFs were badly hit by the Great Crash. Subsequently, laws were created to reform the CEF industry with regulations designed to avoid excessive use of leverage and to protect shareholders’ interests.
Most of the investment trusts in the UK however managed to escape from the crisis by putting their money into fixed interest securities. Yet, due to the competing attractions of other forms of wealth building, such as company pension schemes, life insurance plans, etc., private investors became reluctant to invest their money in the stock market. The investment trusts eventually switched their selling efforts to institutions like insurers that have huge funds but lack investment expertise.
However, as the institutions grew bigger, they started to manage their funds internally, causing the investment trusts to lose their popularity and causing the investment trusts to trade at a discount during this period. Nevertheless, it was the discount that had attracted the big institutions to take over some of the CEFs. New life was brought into the industry through the introduction of new CEFs and the reorganization of existing CEFs. After years of revolution and development, CEFs evolved and diversified into different forms, with different investment philosophies and focus.
In Malaysia, the history of CEFs is very scanty. To date, there is only one CEF listed on Bursa Malaysia namely, Amanah SmallCap Fund Berhad (ASFB). ASFB was launched in April 1997, after a prolonged bull on the KLSE and just before the Great Asian Crisis hit in Jul 1997. Shortly after, this one and only local CEF experienced a sharp fall in its share price and NAV. In Aug 1998, its share price plunged to its all-time low of RM0.25. This caused great disappointment and like many other listed companies, left a bitter taste among Malaysian investors.
Size of the Industry
While CEFs continue to have a poor showing in Malaysia, it has a substantial and growing presence in the major markets of New York and London. It is also an important investment vehicle in stock markets like Shanghai and Shenzen. Clearly, the Malaysian CEF market still has much room to grow.
Table 1: No of CEFs on major stock exchanges, as at 31 Jan 2005
Unit Trust Funds
What are Unit Trust Funds?
Unit trust funds (UTF) are a common type of CIS in Malaysia. Like what the name indicates, it is not incorporated as a company but as a trust where monies are collected from investors to be invested and managed for investors’ benefits. The operations of the trust are governed by a Trust Deed, which effectively forms the constitution of the UTF and details the way in which the UTF operates. It is the trustee’s responsibility to ensure that the unit trust management company (UTMC) complies with the Trust Deed. When investors invest in a UTF, they receive units in exchange for the monies; hence they are known as “unit holders” instead of shareholders like in a CEF.
Types of UTF
Based on the Securities Commission’s guideline, there are 7 types of UTF. The first is the Equity Fund, which is a UTF that invests primarily in stocks/shares. The second, the Bond/Fixed Income Fund, is a fund that invests mainly in debentures. The third, Balanced Fund, is a mix of Equity and Fixed Income fund, which invests in a balanced mix of shares and debentures. The fourth, the Money Market Fund, a relatively small category in terms of numbers of funds, is a fund with investments mainly in short-term debentures, money market instruments and/or deposits with financial institutions. The fifth type is a UTF that guarantees investors the capital invested or returns/income, which is known as Guaranteed Fund. Unlike Guaranteed Fund, Capital Protected Fund, another category of unit trust, is a fund that promises to protect and return investors’ capital, plus returns (if any), at a predetermined date in future through investment in high quality instruments and equities but does not guarantee that investors will get back their initial investment amount. The final type would be the Umbrella Fund, a UTF that consists of at least 2 sub-funds of any category of funds.
History of UTF
In Malaysia, although UTFs have been around 40 years, it was only in recent years that they became widely owned. The first UTMC, the Malayan Unit Trust Ltd, was set up in 1959 and in the same year the first UTF, the First Malayan Fund, was established. In 1979, the government decided to use UTF as a vehicle to redistribute wealth under the New Economic Policy. From 1959 to 1979, only 5 UTMCs were established and 18 funds were set up. In 1981, PNB launched the first national Bumiputra UTF, Amanah Saham Nasional. In Eighties, UTMCs that were subsidiaries of financial institutions also started to emerge, helping the facilitation of the marketing and distribution of UTFs.
The Guidelines on Unit Trust Funds, which have been amended subsequently, were introduced in 1991 to govern the UTF industry. In 1995, a UTMC was allowed to invest up to 10% of the net asset value (NAV) of the UTF in foreign securities. In 1993, the Securities Commission Act vested the Securities Commission with the responsibility to regulate the unit trust industry. In the same year, the Federation of Malaysian Unit Trust Managers was set up to represent the UT industry.
Size of the Industry
The Malaysian unit trust industry grew significantly in the 1990s, as shown in figure 1. Between 1992 and 1996, the industry saw a nearly four-fold increase in its NAV to RM59.96 bln in 1996. However, there was a dramatic 50% plunge in NAV to RM33.57 bln in 1997 due to the Great Asian Crisis. Despite the 1997 setback, the NAV of UTF rose to RM53.70 bln by end of 2002. The NAV of the industry in 2002 accounted for a higher percentage of Bursa Securities? market capitalization at 11.15%, which was 0.97% higher than the 10.18% in 2001.
Figure 1: UT Statistics as at 31 July 2004
As at 28 Feb 2005, there are a total of 36 UTMCs in Malaysia offering over 295 approved UTF. Total units in circulation are a whopping 118.988 bln units. Total NAV of the funds stood at RM88.199 bln, representing 12.16% of Bursa Securities’ market capitalisation.