The closing out of closed-end mutual funds is at the center of a dispute between Templeton Asset Management and Harvard Management Co.
Despite strong performance in some emerging market countries, closed-end funds, which trade on the New York Stock Exchange, unlike open-end funds, are feeling the heat from shareholders looking to improve the discount at which the funds trade to net asset value.
Recently, Templeton - a unit of Franklin Templeton Investments, San Mateo, Calif. - and Harvard Management have butted heads over the issue. Boston-based Harvard Management, which runs the $18 billion Harvard University endowment, is seeking shareholder approval to fire the management team of the Templeton Dragon Fund, a closed-end portfolio that invests in China equities.
The endowment filed papers with the Securities and Exchange Commission, Washington, to that effect earlier this month.
The Dragon Fund is the fourth closed-end fund Harvard has sought to alter this year The common denominator for all of the targeted funds is the discount at which the shares of the funds trade to the net asset value of the fund. Shares of a closed-end fund can trade at either a discount or premium to the fund's NAV, unlike open-end mutual funds, which are bought and sold at net asset value.
Harvard cited the discount at which the shares traded as the primary reason for terminating the investment management relationship with the Dragon Fund. The fund now trades at a 10% discount to net asset value. "Because Templeton has not taken, or caused the fund to take, aggressive steps to eliminate the discount, we are proposing that the investment management agreement between the fund and Templeton be terminated," the SEC filing states.
That was just the beginning.
Templeton responded: "We see the ... proposal as a pressure tactic to cause the fund to (change to) open end or to engage in substantial share buybacks at net asset value in order to reduce the discount and give Harvard greater liquidity in the short-term."
Harvard shot back with a Dec. 13 SEC filing saying it does not seek an open-end structure for the Dragon Fund. Rather it would like to see it merged with the Templeton China Fund, in which Harvard also invests, and an "interval fund" structure put in place, whereby Dragon Fund shares would be sold back through quarterly redemptions. "Open-ending is not the optimal solution. Harvard has consistently sought a better alternative to open-ending: merging the two funds and implementing an interval fund program," wrote Steven Alperin, vice president, emerging markets at Harvard Management, in the SEC filing.
Currently, the China Fund is seeking SEC approval to change to an open-end structure.
Harvard officials would not comment for this article.
Holdings in 26 funds
Harvard is one of the world's largest investors in closed-end funds, holding positions in 26 closed-end funds, most of them investing in country-specific emerging markets. But in the past year, the endowment has sought to terminate relationships with four of the funds: the Asia Tigers Fund; the Credit Suisse Brazilian Equity Fund; Templeton China World Fund; and the Dragon Fund. (The Asia Tigers Fund converted to an interval structure similar to that proposed by Harvard for the Dragon Fund; the Brazilian Equity Fund, in which Harvard had a 31% stake, is seeking shareholder approval to liquidate; and the China World Fund has filed papers to go open-end as a result of shareholder pressure.)
Harvard has sold off shares in two other closed-end country funds this year, the Mexico Fund and the Chile Fund. The Mexico Fund, one of the largest closed-end country funds, with close to $1 billion in assets, has been restructured because of shareholder demand. As a result of pressure from shareholders, the fund now offers to repurchase shares periodically. Shareholders wanted greater liquidity and a narrowing of the discount at which the fund's shares have traded. Laxey Partners, a London-based money manager, led the charge to restructure the Mexico Fund.
Martin Flanagan, vice president at Franklin Resources, said the focus should be on performance, which has been solid, not the discount. Year-to-date through November, the fund returned 17.5% and was among the top-ranked Pacific region funds, according to Lipper Inc., New York.
Hurts manager flexibility
Templeton is against open-ending the fund because it would hamper the manager's ability to invest the assets as effectively as it does under the closed-end structure, said Mr. Flanagan. Also, an interval structure could deplete the assets of the fund significantly, as Harvard is the largest shareholder, with a 14% stake in the $700 million fund, he said.
Gregory Johnson, president, office of the president at Franklin, said the changes would not be in the best interest of the other shareholders of the fund. He also notes the trend toward liquidation or open-ending of country-specific closed-end funds slows the development of emerging market countries.
Thomas Herzfeld, president of Thomas J. Herzfeld Advisors Inc., Miami, a closed-end fund manager and industry expert, said the pressure to narrow the discounts has heightened in this market. He contends that for country-specific closed-end funds, the interval structure might have more merit than open-ending a fund because the latter would handcuff the management team's ability to invest in more illiquid securities and would subsequently lower returns.
Looking at the big picture, closed-end funds don't show up on a lot of institutional investors' radar screens. But interest has picked up in recent years, said Mr. Herzfeld. But as institutional positions in these funds grew to 20%, and 30% in some cases, institutions found their exit strategies were limited.
Brian Smith, president of the Closed-End Fund Association, Kansas City, Mo., concurred, saying the presence of large institutions in these funds has propelled the spate of shareholder activity.
