February 15, 2008 / 8:37 PM / 11 years ago

"Failed auctions" hurting U.S. closed-end funds

BOSTON, Feb 15 (Reuters) - Some top U.S. asset managers that offer closed-end funds are warning their investors of lower returns as the credit crisis has severely disrupted trading this week in an instrument they rely on to borrow and boost fund returns.

Closed-end funds, unlike traditional open-end mutual funds, issue a fixed number of units and trade on exchanges. They borrow by offering preferred securities with short-term maturities of 7 to 28 days. New interest rates are set through an auction process.

This week, the auctions failed as the institutional and wealthy individual investors that usually snap them up have stayed away due to growing concerns about the credit markets.

Banks that normally step in to buy unsold securities also backed out because they are already saddled with vast amounts of various securities whose values have tumbled with the credit crisis.

“A number of auctions for a broad variety of security types through which payment rates are reset and current investors seek to sell their securities have failed,” Nuveen Investments said in a commentary on its Web site on Friday.

Nuveen, BlackRock Inc (BLK.N) and Eaton Vance Corp (EV.N) are among the leading players in the closed-end funds market.

Nuveen said the failed auctions affected at least 25 different fund sponsors. Its funds could see higher borrowing costs, hurting returns, and if the disruptions persisted, Nuveen may have to look for “potentially less favorable” avenues for borrowing, it said.

Citigroup Global Markets said in research report the dividends that closed-end funds pay out may be at risk of being cut. This is because, as per a preset formula, they usually have to pay a higher penalty rate for the failed auctions to holders of the preferred shares, leaving the funds with less.

But on a positive note, the penalty rates had been coming down due to interest rate cuts by the U.S. Federal Reserve, it said in the Feb. 14 report.

Besides closed-end funds, student loan programs and municipalities also issue these short-term securities.

Eaton Vance said on its Web site on Thursday the participants in the market for these securities were in discussions to find solutions to end the disruptions but some said a quick solution may not be at hand.

“We don’t expect an immediate resolution to the current situation,” Citigroup said.

Reporting by Muralikumar Anantharaman, editing by Richard Chang

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