Is your ETF the real thing?

So closed-end fund investors have nothing to go on but their enthusiasm. As recently as last December, Morgan Stanley China A Share Fund was trading at a 16% premium to fair, or net asset, value.

Which price is right?

Similarly, the Nicholas Applegate convertible fund's share price has gone from a premium of more than 7% last December to a discount of 3% now. This mispricing is so egregious and chronic that the Closed-End Fund Association offers tools to search for closed ends by the magnitude of their discount or premium.

According to the group's Web site, Cornerstone Strategic Value (CLM, news, msgs) was trading recently at a premium of 74.8% to NAV. This extremely high-yielding (13.3% currently) equity fund makes its money through complicated lending deals. Its net asset value has gone up only 2% annually over the 10 years ended July 31, but the share price has spurted at a 10.2% rate.

Equus Total Return (EQS, news, msgs), on the other hand, was selling at a discount of 23.7%. Equus invests around the private-equity market, which has fallen flat as credit has dried up.

These are not the sort of funds the average investor would be drawn to. Indeed, that's what makes mistaking closed-end funds for exchange-traded funds so dangerous. The chief selling point of ETFs is that they are easy to understand, and will go up or down on their merits, not due to herd behavior.

Closed-end funds lack this valuable feature. This year, China funds are up nicely but numerous China closed-ends are trading at double-digit discounts to NAV.

Also, closed-ends charge much higher expense ratios than ETFs. The Cornerstone fund charges 1.22%; the Morgan Stanley China fund 1.98%. The FTSE/Xinhau ETF is 0.74%; the Spider 0.10%.

The closed-end fund industry is eager to conceal its warts under ETF makeup because it is withering. Total assets under management grew at an annualized rate of 9.6% between the end of 2004 and this year's first quarter, according to data gathered by the Investment Company Institute. That's barely in line with performance. The entire group has only $312.41 billion in assets.

At ETFs, which have swollen to $444.26 billion, asset growth in the same period was an annualized average of 35%, reflecting massive inflows.

It takes only a little basic research to tell the two creatures apart. ETFs are index funds and most closed-ends are actively managed. If a fund exhibits a significant difference between its share price and its NAV, it is a closed-end.

Also, if a fund is difficult to research it is almost certainly a closed-end fund, because almost no one publishes research on them. Many don't even have Web sites.

Leave these weird creatures to the handful of stockbrokers who specialize in them. When you want to buy an ETF, make sure it's really an ETF.

Meet Tim Middleton at the Money Show

MSN Money's Tim Middleton will be among the dozens of renowned money experts, advisers and analysts sharing their wisdom in free workshops at the upcoming Money Show in Washington, D.C., Sept. 6-8. You'll also have a chance to network with fellow market enthusiasts, exchange investment ideas, share your experiences and enjoy the fellowship of like-minded investors.

Admission is free for MSN Money readers. For complete details or to register for free admission, visit the Washington, D.C., Money Show Web site. Or phone 1-800-970-4355 (be sure to mention priority code No. 007420) and tell them which show you're interested in.

At the time of publication, Tim Middleton didn't own any securities mentioned in this article.

< previous |  1 | 2 |