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By Jeremy Glaser and Cara Esser | 09-05-2012 11:00 AM

5 CEFs That Shine

Morningstar's Cara Esser breaks down our Analyst Ratings for closed-end funds and names the CEFs that are worthy of gold status.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. We launched our Morningstar Analyst Rating for funds for the closed-end fund universe about nine months ago. I am here today with Cara Esser. She is a closed-end fund analyst. We are going to look at the ratings and how they've shaken out so far and what she expects to be some of the best-performing funds in the future.

Cara, thanks for joining me.

Cara Esser: Thanks for having me.

Glaser: So, let's talk a little bit about how you chose the funds to rate and the metrics you use to evaluate these funds.

Esser: We chose the closed-end funds based on size essentially. We wanted to get a good sampling across all of the different strategies that are offered in the closed-end fund space, and as many investors in closed-end funds know, a lot of them are very small. So, we wanted to make sure that we were covering the largest funds that had the most interest, the largest trading volume. Essentially, we picked the largest funds, and then if there were any sister funds that fell below our minimum level of asset requirement, we covered those, as well.

Glaser: What exactly are you looking at? When you evaluate a fund, you decide, "Hey, this is something that we're going to give high rating to, something that we are going to give a negative rating to." What are you looking at?

Esser: Unlike the [Morningstar Rating for funds, commonly referred to as the star rating] which is totally backward-looking based on historical risk-adjusted performance, the Morningstar Analyst rating for funds is purely forward-looking; it's a qualitative rating. We have five pillars that we look at. We call them the four Ps plus fees. So, it's performance, process, people, and parent.

Historical risk-adjusted performance does play a part in the role, but it's only one of five of the pillars. So, we look at the process. We want to know if it's a process that we can understand, that we believe, and that the managers know how to implement successfully and have been able to do so in the past.

We look at the management team, the people. Have they been with the fund for a full market cycle? Is it a cohesive team? Is there a lot of turnover? Do they own shares of the fund?

The parent, we're looking for parents that are good stewards of capital. We want to make sure that they are invested in the long-term shareholder, that they are making decisions that are good for the long-term shareholders and not making decisions based on any kind of short-term trading.

And then fees, obviously, we want to find funds that have low fees. We always prefer low fees over high fees.

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