Anderson S.C., Born J.A., Schnusenberg O. Closed-End Funds, Exchange-Traded Funds, and Hedge Funds: Origins, Functions, and Literature
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Closed-End Funds, Exchange-Traded
Funds, and Hedge Funds
Innovations in Financial Markets and Institutions
Volume 18
Series Editor
Mark J. Flannery
University of Florida
Warrington College of Business
Gainesville, Florida 32611-7168 USA
For further volumes:
http://www.springer.com/series/6103
Seth C. Anderson
l
Jeffery A. Born
l
Oliver Schnusenberg
Closed-End Funds,
Exchange-Traded Funds,
and Hedge Funds
Origins, Functions, and Literature
13
Seth C. Anderson
Tuskegee University
College of Business and
Information Science
Tuskegee AL 36088
USA
profsethanderson@yahoo.com
Jeffery A. Born
Northeastern University
College of Business
Administration
413 Hayden Hall
Boston MA 02115
USA
j.born@neu.edu
Oliver Schnusenberg
University of North Florida
4567 St. Johns Bluff Road
Jacksonville FL 32224
USA
oschnuse@unf.edu
ISBN 978-1-4419-0167-5 e-ISBN 978-1-4419-0168-2
DOI 10.1007/978-1-4419-0168-2
Springer New York Dordrecht Heidelberg London
Library of Congress Control Number: 2009935050
# Springer ScienceþBusiness Media, LLC 2010
All rights reserved. This work may not be translated or copied in whole or in part without the written
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To our families
Preface
Closed-end funds, exchange-traded funds, and hedge funds are three important
vehicles for channeling the savings of U.S. investors into financial assets, both
domestically and abroad. This book traces the origins of these companies and
examines their operational characteristics. It also provides a synthesis of the
academic research to date. Our primary intent is to make the material efficiently
accessible to researchers and practitioners who are interested in the objective
findings and implications of this line of research. We draw from the most widely
cited academic journals, including Journal of Finance, Journal of Financial
Economics, Journal of Financial Services Research, and others, as well as from
practitioner-oriented outlets, such as Financial Analysts Journal and Journal of
Portfolio Management.
We wish to express appreciation to Professor Mark Flannery of the Uni-
versity of Florida, who supported our proposal to undertake this work. We
also want to thank Judith Pforr at Springer for her patience and input. The
completion of the book was greatly facilitated by the editorial work of Linda S.
Anderson. We are most thankful to our patient families.
Tuskegee, Alabama, USA Seth C. Anderson
Boston, Massachusetts, USA Jeffery A. Born
Jacksonville, Florida, USA Oliver Schnusenberg
vii
Contents
1 Introduction ............................................. 1
2 Characteristics of Investment Companies....................... 3
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.2 Open-End Investment Companies . . . . . . . . . . . . . . . . . . . . . . . 3
2.3 Closed-End Investment Companies . . . . . . . . . . . . . . . . . . . . . . 4
2.4 Unit Investment Trusts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.5 Exchange-Traded Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.6 Hedge Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3 A Brief History of Investment Companies ...................... 7
3.1 Early Development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.2 The American Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.3 Reaction to the Crash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.4 Later Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Closed-End Investment Companies . . . . . . . . . . . . . . . . . . . . . . 11
Hedge Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Exchanged-Traded Funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
4 Closed-End Funds Issues and Studies .......................... 13
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
4.2 Cash Flow, Country Funds, and Management Studies . . . . . . . 15
Cash Flow Studies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Country Funds Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Management Studies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
4.3 Perceptions, Expectations, and Sentiment Studies. . . . . . . . . . . 36
4.4 Trading Strategies, IPO, and Idiosyncratic Studies . . . . . . . . . . 49
Trading Strategies Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
IPO Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Other Studies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
4.5 Summary of Research Findings . . . . . . . . . . . . . . . . . . . . . . . . . 71
Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Country Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
ix
Trading Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
IPOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
Perceptions, Expectations, and Sentiment . . . . . . . . . . . . . . . . . 73
5 Exchange-Traded Funds: Issues and Studies .................... 75
5.1 What are ETFs? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
5.2 How ETFs are Created and Priced . . . . . . . . . . . . . . . . . . . . . . 77
5.3 ETFs Compared to Index Mutual Funds . . . . . . . . . . . . . . . . . 79
5.4 Advantages and Disadvantages of ETFs . . . . . . . . . . . . . . . . . . 80
5.5 The Current State of ETFs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
5.6 Research Related to ETFs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Pricing of ETFs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Tax and Operational Efficiency of Exchange-Traded Funds . . . 83
International Diversification of ETFs . . . . . . . . . . . . . . . . . . . . 84
6 Hedge Funds: Issues and Studies ............................. 87
6.1 History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
6.2 The Legal Environment of Hedge Funds. . . . . . . . . . . . . . . . . . 89
6.3 Distinguishing Operational Features of Hedge Funds. . . . . . . . 90
6.4 Review of Selected Academic Articles . . . . . . . . . . . . . . . . . . . . 91
6.5 Summary of Empirical Findings . . . . . . . . . . . . . . . . . . . . . . . . 101
Fees and Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Survivorship Bias and Performance Measurement. . . . . . . . . . . 101
Incentive Fee Structure and Risk Taking Behavior . . . . . . . . . . 102
Hedge Funds Contribution to a Larger Portfolio of Investments 102
Performance Persistence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Trading Strategies and Contagion . . . . . . . . . . . . . . . . . . . . . . . 103
Appendix A: Investment Company Act of 1940: Selected Topics ........ 105
Appendix B: CEF Pricing Issues ................................ 109
References ................................................. 115
Author Index ............................................... 123
Subject Index ............................................... 127
x Contents
Chapter 1
Introduction
Abstract This chapter provides an introduction to the contents of each of the
other five chapters in this volume. Chapter 2 presents an overview of investment
company basics. Chapter 3 follows with a short history of the evolution of these
firms. Chapters 4, 5, and 6 summarize the issues and findings of the research to
date on closed-end funds, exchange-traded funds, and hedge funds.
Keywords Open-end funds (mutual funds)
Closed-end funds (CEFs)
Unit
investment trusts (UITs)
Exchange-traded funds (ETFs)
Hedge funds
Investment companies provide investment management and bookkeeping ser-
vices to investors who do not have the time or expertise to manage their own
portfolios. In the United States, these companies have proliferated and evolved
over the last century; today there are thousands of investment companies with
varying characteristics. They are structured as either open-end funds (mutual
funds), closed-end funds (CEFs), or unit investment trusts (UITs).
In the following chapter, we present an overview of the basic characteristics
of mutual funds, CEFs, and UITs, as well as exchange-traded funds (ETFs) and
hedge funds. Chapter 3 present s a short history of the evolution of investment
companies in the United States as well as an overview of more recent develop-
ments pertinent to CEFs, ETFs, and hedge funds, which are the foci of this
volume.
Chapter 4 address es CEFs, which originated in Europe more than a century
ago. These funds differ from ordinary mutual funds in that they do not con-
tinuously issue or redeem ownership shares. Initially, there is a public offering
of shares, after which the shares trade in the secondary public market.
Chapter 5 involves ETFs, which are investment companies that are typically
registered under the Investment Company Act of 1940 as either open-end funds
or UITs. The shares of ETFs trade in the secondary public market.
Chapter 6 addresses hedge funds, which are private limited partnerships that
accept investors’ money and invest it in a pool of secu rities. Hedge funds are
essentially unregulated, and their shares do not trade in the securities markets.
S.C. Anderson et al., Closed-End Funds, Exchange-Traded Funds, and Hedge Funds,
Innovations in Financial Markets and Institutions 18,
DOI 10.1007/978-1-4419-0168-2_1, Ó Springer ScienceþBusiness Media, LLC 2010
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