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The Fascinating World of Closed-End Fund Filings

Can't tell the difference between an N-CSR and an N-2A filing? We walk through some of the most common financial statements filed by CEFs.

Steven Pikelny, 11/30/2012

Gaining access to financial data is easier than it’s ever been, so today’s investors have never had it so good. For slightly more obscure financial instruments such as closed-end funds, or CEFs, such information is particularly useful. Even though CEFs are usually outside of the limelight relative to stocks and open-end funds, it is pretty simple to find share prices, discounts, z-scores, call exposure, and undistributed net investment income. Nevertheless, investors should avoid being lulled into a false sense of security.

Looking at data points can certainly speed up the research process by condensing massive amounts of information into small, digestible parts, but doing so can also overlook the broader picture. Some relevant data points may not be widely available, while others may be reported incorrectly. Overall, nothing is more reliable than giving regulatory filings a thorough read and then, if you’re so disposed, doing some good old-fashioned financial statement analysis. Navigating these filings, though, can understandably be trickier than simply looking at a data point. With this in mind, let’s run through the litany of CEF regulatory filings.

The Annual Report
When looking through EDGAR, the publicly available regulatory filing warehouse of the U.S. Securities and Exchange Commission, or Morningstar Document Research, the first financial statement on your list should be the annual report, or the N-CSR. Although this document is published only once a year, it contains plenty of useful (and audited) information. The document typically starts with a letter to shareholders written by either the portfolio manager or the chairman of the board of directors. This section is mostly fluff, but some of it can be interesting, especially if you're willing to look back over prior years’ filings. What was the author’s outlook heading into 2008 and 2009? (For a laugh, look at some real estate funds'.) If performance behaved oddly over the past year, for example, the letter would likely address this issue by identifying key contributors and detractors. The section can also provide a general market outlook, as well as the logic behind some of the portfolio’s positions. If the fund is leveraged, does the author explain how the use of leverage affected the portfolio’s total returns? Such questions and a heavy dose of skepticism should accompany the reading of this section of the annual report.

Next, the report will go into portfolio holdings. This usually includes breakdowns of portfolio statistics, geographies, and sector exposures. For certain fund families (such as PIMCO), the annual and semiannual reports are the only places to find important portfolio metrics like credit quality breakdowns. After the breakdown, the current market value of each portfolio holding is listed, typically grouped by sector or geography. The amount of given information can vary, but some fixed-income funds will go as far as providing credit quality, par value, coupon payments, and maturity/call dates for each holding. Derivative positioning is either listed in this section or in one of the notes to the financial statement.

After portfolio holdings, the document will list statements of assets and liabilities, operations, and cash flows. In short, this section will provide the best view of how a fund is constructing its distribution and how it is using leverage. Despite what a fund may claim its leverage ratio is, looking at each line item in the statement of assets and liabilities will always provide a clearer picture. To find the fund’s leverage ratio divide total assets by net assets. The statement of operations provides a breakdown of investment income net of all expenses incurred by the fund, as well as realized and unrealized capital gains. Finally, the statement of cash flows explains the movements of funds due to operating, investing, and financing activities.

For most issues that require clarification, the notes to the financial statement can be useful. While most people find this section the most boring and, thus, skip it, the section can give you a rather deep insight of a fund. It can explain significant accounting policies, specific details on any leverage used, subadvisor agreements, tax information, and occasionally information regarding any derivative positions.

The end of the document can also include information about major policies enacted by the board of directors, as well as information about the portfolio manager. If you are curious about portfolio manager compensation, experience, funds managed, or shares owned of the fund, this is the place to look.

Although the N-CSR is only issued annually, the fund is also required to issue a semi-annual statement (N-CSRS) at fiscal mid-year, and two quarterly statements (N-Q). Although these statements are not audited, they provide timely updates. The N-CSRS is less detailed, but provides much of the same information. The N-Q statement usually only includes a list of the fund’s holdings.

Steven Pikelny is a closed-end fund analyst at Morningstar.

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