diversification benefit of investing in emerging countries can be obtained by investing in ADRs (American Depository Receipts) and OPEN-end mutual fund (to a lesser degree from investing in CLOSED-end MFs). can someone explain why the diversification benefit reduces with a closed-end mutual fund?
Open ended funds track the underlying indices better than closed ended funds. this stems from the fact that the price of the fund varies directly with the market value of its securities and therefore reflects performance better. Closed ended on the other hand are always at a premium or discount to their value. Considering the various idiosyncratic risks associated with Emerging markets (political, etc) open ended funds provide the exposure required at a price which more aptly reflects its true performance.
Open end MF trade at NAV (i.e. the cumulative market value of all the portfolio’s assets) and therefore reflects the true market value of the assets that contributes and un-manipulated representation of the asset characteristics (expected return, standard dev, correlation etc). on the other hand, closed end MF will trade at premiums (or discounts) to the asset’s NAV due to supply and demand forces for shares in the close end fund (these effects are also larger for emerging market funds). Therefore, theoretically the closed end fund’s contribution to a well diversified portfolio is somewhat distorted relative to the true impact the fund should have had on diversification (i.e correlation and covariance with other assets)
thanks all.
Also Closed end fund use leverage hence they can have chances of big negative return due to leverage loss plus emerging market loss (wrong bet)
The detail in your responses is scaring me: I clearly have a long way to go.