Enhanced Exploitation of Closed-end Fund Discounts
August 4, 2014 - Mutual/Hedge Funds
Is there a best way to exploit unusual closed-end fund discounts to net asset value? In their July 2014 paper entitled “Exploiting Closed-End Fund Discounts: The Market May Be Much More Inefficient Than You Thought”, Dilip Patro, Louis Piccotti and Yangru Wu construct two regression models to predict closed-end fund returns:
- One model is a simple regression based on the past relationship between monthly fund discount and next-month fund return.
- The other augments the first by including a term that accounts for effects of changes in the discount over a recent (optimized) interval.
They test whether these models beat a naive strategy that trades only on current closed-end fund discounts. They focus on Sharpe ratio as a key performance metric. Using monthly prices, net asset values and classifications for 377 U.S. closed-end funds as available during August 1984 through December 2011 and contemporaneous monthly four-factor (market, size, book-to-market, momentum) and liquidity factor returns, they find that: Keep Reading