The Scott Letter: Closed-End Fund Report©
Published by Closed-End Fund Advisors, Inc.

February 2002, Volume II, Issue 2
George Cole Scott, Editor

2001 Performance Summary:
Closed-End Funds Post Another Benchmark-Beating Year

Kansas City, Mo. Closed-End funds delivered another benchmark-beating performance for the year 2001, according to the Closed-End Fund Association. Domestic equity closed-end funds delivered +6.5% and -1.6% average total return based on market price and net asset value (NAV) performance, respectively. The category beat the S&P 500 Index, which delivered -13% for the year, by 19.5%. In the previous year, 2000, domestic equity closed-end funds outpaced the S&P by 20.3%, based on market price performance. During 2001, the domestic-equity sector was led by convertible fund performance, which delivered 9.5% and -0.1% average total returns based on market price and net asset value performance.

"Whether you look at closed-end funds by NAV or market price, investors have enjoyed two years of solid performance during very difficult market conditions," said Brian Smith, Executive Director of the Closed-End Fund Association. "Closed-End Funds offer investors an excellent way to diversify their portfolios. The decline in the U.S. equity markets over the past two years has made a strong case for diversification, and closed-end funds should be a part of every investor's asset allocation plan. During market sell-offs, closed-end managers can maintain their investment strategies and are not forced to liquidate holdings to meet redemptions. In addition, investors often seek value through discount investing, particularly during declining markets."

Municipal closed-end funds outpaced all four major categories of closed-end fund performance with a market price return of +12.1%, followed by taxable income funds at +9.1%. The only sector to post negative annual returns was the international sector which delivered -3.9% and -9.3% based on market price and NAV performance. However, the sector was up dramatically from last year when it delivered -23.5% and -22.2% respectively, with market price performance up nearly 14% over the prior year.

What Has Happened to the New Economy?
by H. Bradley Perry

In the heady days of the late 1990s, the economic picture seemed clear to most observers: this time it was different. Driven by rapid, unprecedented technological advances, we were building a New Economy that was far outpacing the stodgy Old Economy and producing a new golden era for America. The driving force in the New Economy was accelerating productivity gains, stemming from new technology. This force is still at work, but there are some signs that it may not have as much sustainable power as the New Economy enthusiasts believed several years ago. The doubts that have arisen are significant enough to deserve close scrutiny by investors — even though more evidence is needed before really downgrading the long-term prospects for future economic growth spurred by technology, after the current recession ends.

The debate over the significance of the New Economy will continue, and current opinions may be clouded by the business recession now underway. Nevertheless, there are some reasons (based on analysis cited here) to doubt that the technology-driven New Economy is as powerful as earlier waves of great invention. Certainly new technological developments and improved management practices will continue to boost productivity, as they always have. The question is: will these make the future just normally good or exceptionally good, as many had expected until recently? Until we know the answer, probably a little caution about the New Economy would be sensible for investors.

Note: H. Bradley Perry writes the Babson Staff Letter, David L. Babson & Company, Cambridge, MA.

An Analysis of Global Economic Trends and Investments
by James R. Libera

A large majority of global markets have risen over the last three months. These rallies have partly been rebounds from the September 11 declines. More recently, markets are also beginning to forecast a U.S. economic recovery. If U.S. growth is delayed beyond the second quarter, we would expect a correction in many markets as projections for global economic and corporate earnings growth are reduced. We are sticking to our previous economic forecast of a gradual U.S. recovery beginning in the second quarter but with a saucer shaped, not a V-shaped pattern. For the year as a whole, we are projecting 1% U.S. growth, about the same in Europe and -1% in Japan. While recovery will be sluggish by standards of recent recessions, we believe it will be sufficient to support positive corporate earnings growth in most countries. We expect modest positive gains in most developed equity markets, somewhat stronger from the emerging markets.

Europe is probably near the bottom of its economic cycle right now, with most economies showing zero or slightly negative growth. We are projecting 1% GDP growth in 2002 for the Euro-area, with about 5% corporate earnings growth. The European Central Bank remains cautious but still has room to cut rates. In the currency markets, we believe the euro will ultimately appreciate versus the dollar, although the timing is unclear. European equity markets are selling at about 18x earnings, roughly 20% cheaper than the U.S. at 22x earnings.

Emerging Asia remains dependent on a resumption of global trade and economic recovery in the U.S. Asian equity markets have already begun to discount a U.S. turnaround, and if it is delayed, markets will give back some of the recent gains. By the second half of 2002, we expect global growth and trade to be trending up. For the year as a whole, we expect significant gains for Asian markets. [Chinese exports rose by a robust 11.4% in December, which could mark the start of a revival in Chinese trade. — Editor]

Latin American markets have been relatively calm in the face of the Argentine default/devaluation. Attention has shifted to the U.S. economy as the major influence on regional markets. We continue to overweight Brazil and Mexico in Latin American portfolios. (Libera's Closed-End Country Fund Report is a monthly publication of Washington International Advisors, Washington, D.C. For more information, e-mail: libera@concentric.net.)

Smart Money Shifting to Europe

"The smart money over the last two years has shifted from the new economy to the old economy. This year, the right move may be from the New World to the Old World: the European market", according to a report in The New York Times.

"To stock investors, the United States has been a more rewarding place than Europe for several years. Since the market lows in September, however, Europe has begun to close the gap, and many strategists in European stocks will benefit more than domestic ones when the economy rebounds from recession," the report adds.

"Our view is that Europe will outperform the U.S. this year," said Steve Tyson, head of global equities at AXA Investment Managers in London. "Europe tends to perform better than the U.S. in economic returns, and it's starting from cheaper valuations," he said.

"The faith based in Europe is rooted in history and valuation. European stocks are relatively cheap. On a price-to-earnings basis, they now cost only 50% of American stocks, on average, compared with 80% historically."

This bolsters our view that Europe is again a place for asset allocation. We have started buying the regional Europe Fund (EF-NYSE) at a 10% discount, rather than trying to guess which country in the region will do best by choosing closed-end country funds.

February 8, 2002. Templeton Emerging Markets Fund (EMF-NYSE) today announced that its 2002 Annual Meeting of Shareholders is currently scheduled to be held on August 26, 2002. As a result the deadline for submissions of shareholder proposals relating to the 2002 Annual Meeting must be submitted in writing and received at the Fund's offices at 500 East Broward Boulevard, Ft. Lauderdale, Florida 33394-3091 no later than March 19, 2002. Such proposals must also meet the other requirements of the rules of the Securities and Exchange Act of 1934, as amended.

The Many Advantages of an Investment Advisor

Investors are often confronted with a dilemma over whether to use an investment advisor or to continue to do the job themselves. Let's try to understand this, recognizing the bias we have towards professional money management. It is first necessary to analyze how one can achieve outstanding investment returns. This is the result of the ability to take advantage of three tools of portfolio management: asset allocation, market timing and security selection, with investor behavior determining the relative importance of each.

According to Yale University's Chief Investment Officer, David F. Swensen, asset allocation is the most important part of diversification and is the best way to lower risk and achieve outstanding results.

"Asset allocation exemplifies the importance of combining art and science in portfolio construction," he writes, whereas "seat of the pants decisions lack rigor, omitting information valuable to the investment process. It involves defining the asset classes that constitute the portfolio and determining the proportion of the fund to be invested in each class. Typical institutional asset classes include domestic equities, foreign equities, fixed income, real estate and private equities."

Instead of treating asset allocation as the central role of determining portfolio returns, Swensen cites studies showing that the secret lies in investor behavior as the determinant of investment success. He adds that in active security selection, "investors hold broadly diversified portfolios and avoid market timing, (this causes) the asset allocation targets to be the most important determinant of investment results." His focus puts market timing and security selection decisions to the background, reducing the degree to which investment results depend upon mercurial, unreliable factors. We are quoting from Swensen's book, Pioneering Portfolio Management. An Unconventional Approach to Institutional Investment (The Free Press. New York, 2000).

Another view is stated in an interview with Michael Kostoff, Executive Director, Corporate Executive Board's Financial Services Practice. Kostoff discusses how investment advice will evolve over the coming decade: "Roles will emerge, with some requiring significant increases in advisors' capabilities. The simplest role will be becoming more involved in clients' portfolio management, which, in many cases, still requires a significant jump in an advisor's abilities. You can't just be a good stock and bond picker. You need a fundamental understanding of client risk profiles and be good at asset allocation, areas in which most brokers today simply aren't very skilled."

Regarding our investment philosophy, we feel the reason we have outperformed our benchmarks most of the time, particularly in the down markets of the last two years, may be because our investment process uses diversification into the following five asset allocation categories: domestic closed-end equity funds, domestic bond funds, closed-end country and regional funds, Real Estate Investment Trusts and individual U.S. stocks.

How the investor decides on an investment advisor includes picking someone who can achieve a better total return through skilled asset allocation. We see too many investors focus on the continuing decrease in commissions as a reason to do it themselves. Commissions are a commodity, and the trends are for a continuing migration towards fee-based relationships and advice rather than trying to achieve a decent return, as most investors have found to be true in the bear markets of the last two years.

A good advisor can “align the interests of the client and advisor, giving both complementary goals: for the client to build wealth over time and for the advisor to build a long term relationship over time where he or she gets paid on an annual basis," is a plan Swensen recommends in his book.

Many people seek an investment firm to try to maximize an investment return they haven’t been able to do themselves. A recent study found that most investors are unable to achieve even a 3% return annually, a result that could prompt them to seek professional advice. A special event in their lives, such as marriage, divorce, or illness, for example, can also prompt the search for another opinion--and lead one to seek an investment advisor to help shoulder the responsibility of managing their assets.

The significance, then, in paying an advisor for this is clear: years of experience are important, and one has to recognize that expertise in asset allocation, stock selection and market timing are what professional money management is all about. Using a strict discipline in each case is  important. Remember that an advisor is on the same side as the clients as compensation is based on increases in asset value rather than trading. A good advisor can quickly capture good prices through buying blocks of stock and fairly allocating shares to clients at low commission rates. This is what we do. Investment results are very important, but one must also consider how much attention the advisor will give each client and how much time he spends talking to them and answering their questions. Whether the advisor is geographically close is less significant than how well he knows his particular niche in the markets and is able to pull it off in a diligent manner.

Then considering an investment advisor, these are some of the factors every investor should consider very carefully. After all, it's your money. Sir John Templeton is right in saying that investing is hard work, and there are no short cuts to investment success. We take his advice seriously.

Renaissance Capital Growth & Income Fund Announces 2001 Performance

Renaissance Growth & Income Fund III, (NASDAQ: RENN), a convertible closed-end fund, announced performance and rankings within the U.S. Convertible Closed-End Sector for the year ending December 31, 2001. According to Lipper Analytical, RENN reported a Net Asset Value (NAV) return of 20.76% achieving the #1 ranking among all U.S. convertible closed-end funds for 2001.The total market return for 2001 is 19.70% ranking RENN #2. The three-year and five-year Total Return for 2001 was 116.46% and 149.96% respectively, earning RENN the #1 ranking among U.S. Convertible Closed-End Funds. The three-year NAV return is 21.01%, also earning the #1 ranking.

Russell Cleveland, Founder and CEO for Renaissance Capital stated, "We are committed to providing the public with investment vehicles like RENN, some of the best opportunities in the U.S. market are private placements in emerging growth companies. RENN gives investors the opportunity to invest in private placements of convertible securities." We will feature an interview with Russell Cleveland in the March Scott Letter Online.

Best of luck, and be sure to call us about any questions you might have.


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Note: None of the information contained herein should be construed as an offer to buy or sell securities or as recommendations. Performance results shown should under no circumstances be construed as an indication of future performance. Data, while obtained from sources we believe is reliable, cannot be guaranteed.

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