The Discount Delusion - The Swedish Closed-End Fund Premium Puzzle

Abstract: The final piece to the Closed-End Fund Puzzle has long eluded researchers and practitioners alike. Many attempts have been made in order to explain the existence of persistent discounts on their net asset values with varying results that sometimes outright contradict each other. We contribute to the discourse of discounts by using a unique dataset consisting of daily observations of 11 Swedish CEF discounts from January 2000- December 2012 that has been continually been constructed by professionals. We believe that the quality of the data is optimal for a study trying to establish a connection between continuous variables studied in the paper and a big improvement over the often quarterly data that researchers have used in the past. In addition, we study fund managements' ability to generate abnormal returns, and test whether current levels of discounts have predictive power over future performance and costs using both tried methods as well as new and refined ones. Our results indicate that high dividend yields, managerial ability and the ratio of illiquid assets reduce discounts. Surprisingly, high management fees only showed small positive effects on the level of discount. Finally, we find that discounts are negatively correlated with future abnormal returns. Those who buy high discount CEFs thinking that they are bargains will have the numbers against them; the apparent undervaluation of the assets is only a delusion.