A Tour of Our New Closed-End Fund Reports

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser.

We recently launched our Premium closed-end fund Analyst Reports. I'm here with closed-end fund strategist, Mike Taggart, to take a look at what goes into making these new reports and what investors can expect in the future.

Mike, thanks for taking the time today.

Mike Taggart: Yeah, thanks for inviting me.

Glaser: So, can you give us a quick overview of how we're launching our new closed-end fund research?

Taggart: Yes, certainly, well, we've been covering closed-end funds just, in general, more educational, topical type pieces, looking at the closed-end fund universe as a whole for about nine months now. And alongside that effort in the background, our closed-end fund analyst Cara Scatizzi and myself have also been working on putting together these closed-end fund reports, which are going to be reports on individual closed-end funds.

Glaser: So, let's talk a little bit about what you can expect to see in these reports. What are some of the major sections that are in there?

Taggart: Well, there are a lot of sections. We think all of them are important, but they're very lengthy reports.

So, we do have a Morningstar opinion, which we think that people considering a closed-end fund would want to start there, and that's going to be on the top. Those are basically the three items that anybody that's looking to invest in this particular closed-end fund, would want to know before they invested and dug any deeper.

Then after that, we have things such as the portfolio process. How does this portfolio management team kind of go about selecting securities for their portfolio. Then we look at, how is the portfolio positioned? Does the positioning of that portfolio actually mirror what they are telling us or is it something completely different? We look at NAV performance historically. Things that are related to closed-end funds, specifically, like discounts, leverage, those sorts of topics.

We also take a pretty good look at the people who are running the fund, the parent company of the fund and also the board of directors. So, under the board of directors, it's not only like who are these people, but also what kind of stewards are they being. Is there discount control mechanism in place for the closed-end funds? How are they doing with the distributions on the closed-end funds? Is this a fund that is returning too much distribution and bad return of capital to shareholders or are they doing a good job with the cash flow control?

Glaser: When you are crafting these reports, how do you do your research? How do you get the information that feeds into your opinion?

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Taggart: We obviously look at regulatory filings of the funds, news releases, that sort of things, whatever they have, and we get our hands on all the written material.

And then we reach out to the management companies to speak with somebody on the fund about the fund, to find out more about the strategy. In some cases, where fund companies don't want to speak to us about the particular fund, we haven't been able to pick up coverage, simply because we're also having a qualitative rating that goes along with this, and we need some information from an interview format to feed into that opinion.

But in other cases we feel where we feel that there is enough information in the regulatory filings to make an informed opinion, we'll go ahead and do that. But we do reach out, and for the majority of cases, I mean, we're covering 100 funds, I'd say probably 90 of them we've talked to the management.

Glaser: Now, during these interviews and during your research process, has there anything surprised you that you weren't expecting starting the research?

Taggart: There are, I think, two things. One is the length of everything that's involved with looking at a particular fund, just the various different segments that need to be looked at and compared to and the kind of the depth of research that we're able to do.

Secondly, just how willing the fund management companies are to speak with us, and they answer the questions that we have. A lot of times we'll call them and they'll try to walk us through the pitch and we're always glad to listen to the marketing pitch or whatever. But I think they've been surprised a lot of times by the questions, especially Cara asks them, has come up with and myself.

But just trying to dig deeper and trying to get some real information out of them as to what differentiates maybe their process from a competitor's process and that sort of thing.

Glaser: How have you seen that these managers processes differ from say, an open-end fund manager who we might be more familiar from hearing from?

Taggart: That's hard because I don't know, I don't have experiencing covering open-end funds, but one of the things that makes the closed-end fund unique from the open-end fund is just the close capital structure and the leverage that they are therefore able to take on.

So, that's definably something that we focus on when we speak to them is how do you use leverage, and how does that feed into your decision-making process when you are maybe in a more volatile environment. We have the numbers and the data that backs up how they've performed in the past downturn and in volatile periods, but it's always good to hear from the horse's mouth how they think that they performed and how they're positioned for rocky times ahead.

Glaser: Mike, you mentioned earlier that we're launching a new closed-end fund qualitative rating. Can you talk to us little bit more about that?

Taggart: Yes, certainly. Well, this is something to augment the Morningstar rating, the star rating. The star rating, as our viewers are aware, is a risk-adjusted return rating, and so it's backward looking.

What the qualitative rating is more in terms of what's the quality of this fund, and it looks at various metrics and various aspects of a fund.

So, it looks at the parent company, the people who are running it, the performance, the process and the fees. And just as we interview people, and we get information from the regulatory filings, it's just saying how does it stack up against other funds that are in this category in terms of how sound and how well we think that this fund is positioned to do for its shareholders, rather than maybe for the parent company's shareholders, which would be a different matter.

So, the idea would be that there are five ratings; from the top it goes: Elite, Superior, Standard, Inferior and Impaired.

So, I try to think of it a little bit like maybe the economic moat rating for a stock, in the sense that you're trying to separate the wheat from the chaff. But it doesn't mean that an Elite fund would have a moat, an economic moat, that's not what I mean, but it's a way to separate the quality of funds one from another. And an Impaired fund, of course, would be a fund that we think there is something structurally unsound about this fund, and therefore we don't think people should consider it for investment.

Glaser: How often will you have to go back and revisit your research and update your reports?

Taggart: Well, certainly anytime there is fundamental news out on a fund--whether it changes its distribution rate. We get on the phone and call the company if there's a major change to find out what's going on there with the cash flow management. If there is a manager change, we'll call up, find out, put a little note out and then change the pertinent sections of the report.

But barring any major change like that, we will expect to go back and revisit our reports every four to six months.

Glaser: Mike, thanks for taking the time. It sounds like could be a great research for investors.

Taggart: Yeah. Thanks for having me, Jeremy.

Glaser: For Morningstar.com, I am Jeremy Glaser.