Managing a Closed-End Investment Fund

Abstract

Closed–end investment funds tend to sell at a discount to the market value of their investment assets. The two primary measures of success are the returns earned by the fund's investors (before– and after–tax) and the extent of the fund's market approves of management's performance. This article considers the implications to a fund's management of these two measures of success. While there are many different explanations for these discounts, the authors focus on two tax effects and the resulting paradox. One tax effect is the fund's unrealized capital gain and the implicit future tax liability associated with it. The second tax effect is the value discount a tax–aware potential investor requires if the fund will realize future capital gains in a finite time period more rapidly than the investor would realize with a direct investment.