1401 H Street, NW, Suite 1200 Washington, DC 20005 202/326-5800 www.ici.org Research fundamentals Sandra West, ICI Director of Investor Research, and Victoria Leonard-Chambers, ICI Assistant Director of Investor Research, prepared this report. March 2006 Vol. 15, No. 3 The Closed-End Fund Market in 2005 What Is a Closed-End Fund? A closed-end fund is a type of investment company that generally issues a fi xed amount of shares which are listed on a stock exchange or traded in the over- the-counter market. The assets of a closed-end fund are professionally managed in accordance with the fund’s investment objectives and policies, and may be invested in stocks, bonds, and other securities. Closed-end funds offer a fi xed number of shares to investors during an initial public offering. At some point, a closed-end fund may make additional public offerings of its shares in order to raise additional capital. Once issued, the shares of a closed-end fund are not typically purchased or redeemed directly by the fund, but rather, investors buy and sell shares in the open market. Because a closed-end fund does not need to maintain cash reserves or sell securities to meet redemptions, the fund has the fl exibility to invest in less liquid portfolio securities. For example, a closed-end fund may invest in securities of very small companies, municipal bonds that are not widely traded, or securities traded in countries that do not have fully developed securities markets. Closed-end funds also have considerable fl exibility to borrow against their assets, allowing them to use leverage as part of their investment strategy. Key Findings Assets in closed-end funds increased for the fourth consecutive year: At year-end 2005, assets in closed-end funds totaled $276.3 billion. Closed-end fund assets have increased 93 percent since year-end 2000. Equity funds continue to increase their share of total closed-end fund assets: While bond funds accounted for nearly two-thirds of closed-end fund assets at year-end 2005, closed-end equity fund assets have grown at a faster rate during the past four years. Closed-end fund owners tend to be experienced investors: An estimated 2.0 million U.S. households owned closed-end funds in 2005. The typical closed-end fund owner is older, has accumulated more household f inancial assets, and owns a broader array of investments than the typical U.S. household f inancial decisionmaker. • • • Page 2 Fundamentals March 2006 Vol. 15, No. 3 Closed-End Fund Assets Increase Assets in closed-end funds grew in 2005, marking the fourth consecutive year of increasing assets. At year- end 2005, assets in closed-end funds reached $276.3 billion (Figure 1).1 Closed-end fund assets have grown 93 percent during the last fi ve years. In 2005, closed- end fund assets increased 9 percent. Figure 1 Closed-End Fund Assets Increase for Fourth Consecutive Year Closed-end fund assets at year-end, billions of dollars, 1995–2005 142.6 20052004200320022001200019991998199719961995 147.0 151.8 155.8 147.0 143.1 141.3 158.8 214.1 254.3 276.3 source: Investment Company Institute Figure 2 Bond Funds Are Largest Segment of Closed-End Fund Market Closed-end fund assets at year-end by investment objective, billions of dollars, 1995–2005 $0 $20 $40 $60 $80 $100 20052004200320022001200019991998199719961995 Domestic Municipal Bond Domestic Taxable Bond Global/International Equity Domestic Equity Global/International Bond source: Investment Company Institute Bond funds have accounted for the vast majority of assets in closed-end funds for the past decade (Figure 2). At the end of 2005, bond funds held $171.7 billion, or 62 percent of closed-end fund assets. Equity funds totaled $104.6 billion, or 38 percent of closed-end fund assets. March 2006 Vol. 15, No. 3 Fundamentals Page 3 Figure 4 Number of Closed-End Equity Funds Accelerates After 2000–2002 Stock Market Contraction Number of closed-end funds, 1995–2005, selected years 1995 2000 2001 2002 2003 2004 2005 All Closed-End Funds 500 482 493 545 586 619 634 Equity Closed-End Funds 141 123 116 123 130 157 191 Domestic 49 53 51 63 74 95 119 Global/International 92 70 65 60 56 62 72 Bond Closed-End Funds 359 359 377 422 456 462 443 Domestic 326 329 349 397 429 432 412 Taxable 119 109 109 105 131 137 131 Municipal 207 220 240 292 298 295 281 Global/International 33 30 28 25 27 30 31 source: Investment Company Institute Equity funds, however, have fueled about half of the recent growth in closed-end fund assets. From year- end 2000 through 2005, assets in closed-end equity funds increased by $68.0 billion, or 186 percent, while assets in closed-end bond funds rose by $65.2 billion, or 61 percent. The role of equity funds in the recent growth of closed-end fund assets is also evident when proceeds from initial and additional public offerings of equity and bond funds are compared. In 2004 and 2005, proceeds from initial and additional public offerings of equity funds greatly exceeded those of bond funds; the reverse was true in 2002 and 2003 (Figure 3). Number of Closed-End Funds Increases The number of closed-end funds available to investors has also increased over the past several years. At the end of 2005, there were 634 closed-end funds, up from 482 at the end of 2000 (Figure 4). As with closed-end fund assets, equity funds accounted for about half of the increase in the number of closed-end funds during this fi ve-year period. While the majority of these equity funds invest in a broad mix of U.S. companies, many of the closed-end equity funds introduced since 2002 have been real estate and energy sector funds. Figure 3 Closed-End Equity Fund Share Issuance Surges in 2004 and 2005 Proceeds from the issuance of initial and additional public of ferings of closed-end fund shares, year-end, millions of dollars, 2002–20051 2002 2003 2004 2005 Total Proceeds From Closed-End Fund Share Issuance 24.9 41.0 27.9 21.2 Equity fund share issuance 9.2 10.8 21.2 19.2 Bond fund share issuance 15.7 30.2 6.6 2.1 1Data is not available for years prior to 2002. note: Components may not add to total because of rounding. source: Investment Company Institute Page 4 Fundamentals March 2006 Vol. 15, No. 3 Closed-End Fund Owners Are Experienced Investors With Diversifi ed Portfolios An estimated 2.0 million U.S. households held closed-end funds in 2005 as part of their investment portfolios.2 These households tend to include affl uent, experienced investors who own a range of equity and fi xed-income investments. In 2005, 95 percent of closed-end fund investors also owned individual stock either directly or through mutual funds (Figure 5). Seventy percent owned individual bonds, bond mutual funds, or fi xed annuities. In addition, nearly half of these investors owned investment real estate. Because a large number of closed-end fund investors also own individual stock and mutual funds, closed-end fund investors are similar in many respects to the individuals who own these investments. For instance, closed-end fund investors, like individual stock and mutual fund investors, tend to be college- educated and have household incomes above the national average (Figure 6). Figure 5 Closed-End Fund Investors Own a Broad Range of Investments Percent of closed-end fund investors owning each type of investment,1 2005 Stock Mutual Funds or Individual Stock 95 Bond Mutual Funds, Individual Bonds, or Fixed Annuities 70 Mutual Funds (total) 89 Stock mutual funds 69 Bond mutual funds 54 Hybrid mutual funds 57 Money market mutual funds 57 Individual Stock (total) 86 Individual stock other than company stock 81 Company stock through employer 30 Individual Bonds 33 Annuities (total) 44 Variable annuities 39 Fixed annuities 19 Investment Real Estate 46 1Multiple responses are included. source: Investment Company Institute March 2006 Vol. 15, No. 3 Fundamentals Page 5 Nonetheless, closed-end fund investors exhibit certain characteristics that distinguish them from individual stock and mutual fund investors. For example, closed-end fund investors tend to have much greater household fi nancial assets than either individual stock or mutual fund investors. Closed-end fund investors are also more likely to be self-employed or retired from their lifetime occupations than either individual stock or mutual fund investors. Ownership of bond investments traditionally has been greatest among older individuals and households in the highest income and wealth groups.3 Because bond funds account for a large portion of closed-end fund assets, investors in these funds tend to have demographic characteristics similar to those of bond investors in general. Figure 6 Closed-End Fund Investors Have Above-Average Household Incomes, Financial Assets All U.S. Households1 Households Owning Closed-End Funds1 Households Owning Mutual Funds2 Households Owning Individual Stock3 Median Age of head of household 47 50 48 53 Household income $45,000 $75,000 $68,700 $74,000 Household fi nancial assets4 $60,000 $370,400 $125,000 $205,000 Percent Household primary or co-decisionmaker for investing: Married 53 52 71 74 Widowed 11 19 5 8 Four-year college degree or more 38 59 56 64 Employed (full- or part-time) 66 60 77 64 Self-employed5 18 36 16 24 Retired from lifetime occupation 26 46 21 35 Household owns: IRA 41 64 69 73 Defi ned contribution retirement plan account 53 57 64 62 1Investment Company Institute Annual Mutual Fund Tracking Survey, 2005 2Investment Company Institute, Profile of Mutual Fund Shareholders, Fall 2004 3Investment Company Institute and Securities Industry Association, Equity Ownership in America, 2005 4Household f inancial assets excludes primary residence, but includes assets in employer-sponsored retirement plans. 5among those who are employed note: Number of respondents varies. sources: Investment Company Institute and Securities Industry Association Page 6 Fundamentals March 2006 Vol. 15, No. 3 The ICI Research Department maintains a comprehensive program of research and statistical data collections on investment companies and their shareholders. The Research staff collects and disseminates industry statistics, and conducts research studies relating to issues of public policy, economic and market developments, and shareholder demographics. For a current list of ICI research and statistics, visit the Institute’s public website at www.ici.org/stats/index.html. For more information on this issue of Fundamentals, contact ICI’s Research Department at 202/326-5913. Copyright © 2006 by the Investment Company Institute The Investment Company Institute (ICI) is the national association of U.S. investment companies. ICI seeks to encourage adherence to high ethical standards, promote public understanding, and otherwise advance the interests of funds, their shareholders, directors, and advisers. Notes 1 See the Investment Company Institute’s (ICI) Closed-End Fund Survey. The survey was conducted annually from 1988 through 2001, and quarterly since 2002. 2 Based on a June 2005 ICI survey of 3,000 randomly selected U.S. households. The survey’s standard error for the sample of 3,000 households is +/- 1.8 percentage points at the 95 percent confi dence level. The sample is weighted to match the age distribution of the U.S. population. The number of U.S. households owning closed-end funds is based on the U.S. Census Bureau’s estimate of 113.1 million total U.S. households as of March 2005 (see U.S. Census Bureau, Current Population Reports, Series P60-229, Income, Poverty, and Health Insurance Coverage in the United States: 2004, August 2005 (www.census.gov/prod/2005pubs/p60-229.pdf)). 3 See Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore, “Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” Federal Reserve Bulletin (2006), p. A14 (www.federalreserve.gov/pubs/ bulletin/2006/fi nancesurvey.pdf).