The United Kingdom closed-end fund discount

Closed-end funds are characterized by one of the most puzzling anomalies in finance--the existence and behaviour of the discount to NAV. Closed-end fund shares are issued at up to a 10 percent premium to NAV. This premium represents the underwriting fees and start-up costs. Subsequently, within a matter of months, the shares trade at a discount, which persists and fluctuates according to a mean-reverting pattern. Upon termination (liquidation or 'open-ending') of the fund, the share price rises and the discount disappears.; This study focuses on the world's largest market for closed-end funds, the London Stock Exchange, and extends research previously carried out on the US market. We examine the extent to which the discount on closed-end funds can be explained by the quality of a fund's management. Using a comprehensive sample of British funds, we use Sharpe's (1992) returns-based style analysis to measure manager quality after adjusting for factor exposure. We find no evidence of performance persistence amongst closed-end funds, and no indication that fund discounts reflect expected managerial performance. We also show that when a fund has high residual risk, its discount is likely to be more extreme.; We also attempt to develop a model of the discount generating process. Based on the results of Pontiff (1997), we first take into account market risk, small firm risk, and sentiment risk. An attempt is made to explain at least part of the largely idiosyncratic movements in the discount by introducing additional factors. We investigate the importance of mean-reversion, manager, past performance and once reversal measures. The results show that this extended palette of factors can explain approximately 35 percent of the changes in the discount.