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From the Closed-End Fund Mailbag

Morningstar's Mike Taggart responds to readers' comments and suggestions on Morningstar CEF coverage as well as investors' understanding of the asset class. 

Mike Taggart, CFA, 04/19/2013

While we make a concerted effort to respond to comments posted on our articles and to user feedback emails dropped into our inboxes, time often constrains our ability to do so. At other times, comments seem to build from one reader to the next, leading to a crescendo that ultimately calls for a response. Thank you for reading and writing in--we always welcome your feedback.

I find Morningstar's CEF coverage very useful, but you don't seem to provide coverage on many CEFs.
Figuring out a coverage list for any group of securities is actually a tricky business, especially since providing coverage on a full universe is unlikely to make sense from a resource perspective (time and effort versus value ultimately added). With the United States-traded closed-end fund universe this is particularly tricky because most of the funds are relatively small. There are 597 CEFs traded in the U.S., according to Morningstar's Traded Funds Center, with total assets under management of $321.5 billion as of April 18; 48% of all assets are clustered in the largest 100 CEFs. In other words, 48% of all CEF investors' money is in those top 100 CEFs.

To make our coverage universe relevant to the largest number of CEF investors, we chose to focus on the largest. As we disclose in our CEF rating methodology paper, "In determining coverage, analysts evaluate fund net assets under management and average daily trading volume as a gauge of investor interest, and include "sister" funds of these larger funds." We reserve the right to alter our coverage list by adding coverage or dropping coverage as we see fit, but our goal remains to use our resources in a manner that allows coverage of the CEFs that are most relevant to all CEF investors. As of March 31, we are providing full analyst reports on 125 CEFs, representing approximately 47% of the universe. These reports are available to premium subscribers of all Morningstar products, including our website.

Aside from our reports, we have written Specialist articles on many CEFs that do not get full coverage. The CEF Specialist archive can be found here. In addition, we attempt to provide commentary on the entire U.S.-traded CEF universe through our weekly articles and weekly updates.

We understand that covering 125 CEFs from a universe of 597 isn't ideal, but the disparity in CEF size across that universe means we had to make some tough resource allocation decisions.

Many investors don't properly understand CEFs, which makes them dangerous investments.
That's summarizing several lines of thought expressed in reader feedback. We agree: if investors don't understand what they're investing in, a bad outcome is likely. Our aim is to help educate CEF investors and those interested in becoming CEF investors. We seek to achieve this goal through educational articles and through our CEF Solutions Center. Much has been done, but unfortunately much work remains. No matter the resources available, some people will continue to make basic investment mistakes to their own detriment.

Conversely, many readers seem to want to maintain general investor ignorance of proper CEF investing. Usually, they couch this wish in humorous language. If you are in the know, information asymmetry works to your advantage. However, over the long term market inefficiency benefits nobody. After all, if you invest in a deeply discounted CEF in the hope that the discount will narrow, you are making the explicit bet that a current inefficient market in that CEF becomes efficient over time. More education, more advocacy, and more awareness make for better investments and better markets, in our view.

Morningstar should offer both a CEF newsletter and model CEF portfolios.
We have considered both ideas. However, we came to the conclusion that it's not a good idea right now. Our view is that investors should approach portfolio building by first making asset-allocation decisions and then determining which investment vehicle--whether individual securities, mutual funds, CEFs, or ETFs--is most appropriate for their portfolio. In our Analyst Reports, we include a section for a fund's role in a portfolio.

Mike Taggart, CFA, is the director of closed-end fund research at Morningstar.

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