Scandal-Free Mutual Funds

Exchange-traded funds can shelter investors from mutual fund abuses

more. A mutual fund will have to sell those stocks, take profits, and pass on the taxable gains to shareholders. You might purchase shares in a mutual fund April 1 and owe tax on a trade that the fund makes April 2, even though you didn’t participate in the gain that’s being taxed.

By comparison, ETFs are allowed to use techniques that minimize such phantom taxation. “Your basis is the price you pay for the shares,” explains Clark. “You’ll have a taxable gain or loss depending on the price you get when you sell the ETF shares. You control your tax obligations.”

The Case for Closed-End Funds
William Adams IV, executive vice president of Nuveen Investments in Chicago, asserts that closed-end ETFs offer additional benefits to investors: “Managers don’t have to be concerned with redemptions so they needn’t hold a great deal of cash.” Over a long time period, cash holdings, such as money market funds, will likely have lower returns than the stocks and bonds where closed-end funds put their money. “Closed-end funds also avoid the timing issues that redemptions can bring,” says Adams. That is, money often flows into mutual funds at market highs, leading to high-priced buys, and flows out near market bottoms when the fund could use extra cash to buy bargains. That’s not an issue with redemption-free closed-end ETFs.

What’s more, closed-end ETFs generally sell at a premium or discount to the securities they hold. A fund might hold $100 million worth of stocks (at current market prices) and have 10 million shares outstanding for a per-share value of $10. Funds trading on an exchange, however, might be priced at $10.50 per share, $9.50, or even $9. “Buying closed-end funds at a discount can be a major advantage to investors,” says Adams.

“Currently, many closed-end funds sell at a discount,” says Thomas Herzfeld of Herzfeld Research in Miami. “Investors have pulled money out of some closed-end funds managed by the same companies that have been named in the mutual fund scandals. As demand for these funds has dropped, discounts have grown larger. Buying closed-end funds at a discount may be the best choice for investors.”

Top 10 Closed-End ETFs by 3-YearNAV Return (Through Feb. 29, 2004)

Fund Name

Exchange: Ticker

Category

NAV
1-Year
Return

NAV
3-Year
Return

NAV
5-Year
Return

Templeton Russia NYSE: TRF Europe Stock 67.05 40.85 35.03
MS Eastern Europe NYSE: RNE Europe Stock 82.34 36.59 25.98
Thai Fund NYSE: TTF Pacific/Asia Stock* 108.31 35.56 19.89
China Fund NYSE: CHN Pacific/Asia Stock* 78.95 33.81 29.42
First Financial NYSE: FF Specialty — Financial 55.71 33.23 27.67
Indonesia Fund NYSE: IF Pacific/Asia Stock* 114.14 32.08 11.57
Thai Capital NYSE: TF Pacific/Asia Stock* 101.06 31.29 8.39
Korea Fund NYSE: KF Pacific/Asia Stock* 58.82 26.44 25.74
Renaissance G&I III NAS: RENN Mi
d-Cap Blend
140.99 25.77 22.79
Templeton Dragon NYSE: TDF Pacific/Asia Stock* 83.61 24.99 23.40
Source: Morningstar Inc. Morningstar makes every effort to ensure the completeness and accuracy of this data but cannot guarantee it.
*Fund excludes Japan.

Top 10

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