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

January 2003, Volume III, Issue 1
George Cole Scott, Editor

This Market Is in a Major Bottom Area

We’ve said it many times, but it is important to be clear on a matter like this. We think the market is in a major bottom area, and this is no time to sell. We would love to say mortgage your house, sell your kids and buy stocks, but nothing is ever that sure. However, it’s time to be a buyer.

Every investor will run into three or four bear markets over the years. If he sells out after every big drop and only buys back in when he feels comfortable, his results will be terrible. He’ll always buy high when the outlook is great and sell low when securities are cheap because of all the problems.

In the long run, stocks have produced an average annual rate of return that is twice as large as fixed-income investments. But this is only for investors who hold onto them through thick and thin. Efforts to forecast whether stocks will go up or down have not paid off. As Charles Ellis puts it in his wonderful book, Winning The Losers Game, “Just as there are old pilots, there are no investors who have achieved recurring success in market timing.

The primary available choices today are money market funds at less than 2%, Treasury notes around 3-4% or stocks. Where do you think the money is going to be made over the next five years?”

Source: Bowling Portfolio Management, November 2002 newsletter

Restating the Case for International Investing

In the early 1990s, international stock diversification gained much attention in the United States. Behind this attention were two decades in which U.S. investors who committed a portion of their stock portfolios abroad obtained greater investment returns with less volatility than those who maintained a U.S. portfolio only. Ironically, from 1990-1999 the situation reversed, especially during the latter half of the decade, and although investors continued to enjoy reduced volatility, it came at the expense of lower investment returns. Meanwhile, the performance of stock markets abroad became more closely correlated with that of the U.S. stock market. These two events have led some people to conclude that international diversification no longer benefits U.S. investors.

We disagree. By definition, diversification implies performance differentials among assets over a given period. The period is critical; the short term is often a poor indicator of long-term trends. This is true for stocks, industries, countries, currencies, and investment styles. The performance differential reveals the costs of diversification & the savings from the risk of being exactly right. However, because these costs can only be determined at the end of a period, we believe that it makes sense to diversify. The question remains how.

Mapping Out a Strategy

In the past, a diversification strategy based solely on selecting the last year’s best performers often has proved disastrous, for good reason. It ignores the crucial fact that investment decisions should be made looking forward. Templeton’s investment strategy has always focused on identifying companies around the globe that we believe are selling at substantial discounts to their potential long-term value. This requires in-depth balance sheet and income statement analysis, which we do rigorously. Ultimately, however, prospective earnings are the main drivers of stock prices, and, as such, these earnings have always been fundamental in our stock selection.

Corporate industry consolidation continues to intensify global competition. Over the past few years, cross-border acquisitions, joint ventures, and international alliances have led to the emergence of global industry leaders.

Some non-U.S. companies among the top 10 in their global sector are well known in the United States (e.g. Sony, Bayer, Nokia, Phillips, Toyota).

U.S. investors who do not diversify internationally forego the potential rewards from investing in some of the world’s largest companies and also in smaller non-U.S. companies offering solid financial fundamentals and strong management teams.

Emerging Markets

Emerging markets, popular in the 1980s, grew increasingly out of favor during the mid to late 1990s. However, in 2001, a combination of lower valuations and higher growth rates in emerging markets attracted some U.S. investors who were disappointed with the performance of the domestic stock market. In addition, an anticipation of economic recovery in the developed countries improved the outlook for exports from emerging economies.


Within an overall investment strategy, diversification is critical to reduce risk and maximize potential investment returns. With the global economy becoming more and more intertwined, the location of a company on the globe is secondary. In our opinion, a diversified, risk-aware approach to non-U.S. investing has the potential to yield real return and risk benefits to investors.

We are optimistic about the outlook for non-U.S. stocks and believe that lower valuations and positive growth prospects abroad should continue to attract the attention of U.S. investors. Although past performance cannot guarantee future results, at Templeton our demonstrated consistent approach to borderless global investing has yielded our clients real and measurable benefits over the last decade. We invite you to learn more about our capabilities by contacting our Institutional Response Team at 800-322-6712 or visiting us at

This report is condensed from the Franklin Templeton web site. For the entire report and more information on Franklin Templeton Investments, go to

San Mateo, CA, December. 11, 2002. Franklin Templeton Investments, whose Templeton Asset Management unit manages Templeton Dragon Fund (the Fund), today responded to a proposal submitted by the President and Fellows of Harvard College for the Fund's 2003 annual meeting of shareholders, calling for the termination of the investment management agreement between the Fund and the manager. The following is a statement by Franklin Templeton Investments in response to that proposal:

Franklin Templeton Investments strongly opposes the Harvard College President and Fellows' proposal. Templeton Asset Management's primary job is to manage the Fund's assets, and it has achieved strong relative performance--a fact Harvard does not dispute. Based on Harvard's statements and on conversations that Fund management has had with Harvard representatives, we believe Harvard's proposal is a tactic aimed at imposing a self-serving, short-term agenda on the Fund by trying to influence the Board of Directors of the Fund to pursue open-ending or to take other actions which would benefit Harvard but could deplete the Fund's assets to the detriment of the Fund's long-term investors.

According to Lipper Analytical Services, the Fund was the top ranked Pacific Region fund of the six in its Lipper category based on both market price and net asset value for the six-month, year-to-date, one- and three-year periods ended November 30, 2002. It ranked second out of six funds based on market price for the five-year period ended November 30, 2002, and third for the period since its September 1994 inception. We find it troubling that the President and Fellows of Harvard College want to remove the investment manager who is producing these solid results.

Harvard's complaint about the manager is that the Fund's shares trade at a discount to net asset value. However, as we have pointed out, the manager's primary focus must be on managing the Fund's investment portfolio not on trying to eliminate the discount, which is the result of market forces not within the manager's control. Based on Harvard's statements and on conversations between Fund management and Harvard representatives, we see the Harvard College President and Fellows' proposal as a pressure tactic to cause the Fund to open-end or to engage in substantial share buy-backs at net asset value in order to reduce the discount and give Harvard greater liquidity in the short-term, regardless of the cost to long-term shareholders. Our view is further supported by the fact that Harvard has acquired substantial shareholdings at, we believe, significant discounts to net asset value in at least four other closed-end emerging markets funds and later made, or threatened to make, proposals to terminate the investment management agreement, citing in certain instances the 'discount' as a reason for its actions.

Although conversion to an open-end fund or substantial share buy-backs, at or near net asset value, could eliminate or produce a short-term narrowing of the discount, the Board of the Fund must consider whether these actions may be more in the interests of shareholders seeking short-term profits than those seeking long-term capital appreciation. In less liquid markets, a closed-end fund can be managed with a view toward achieving long-term portfolio returns without the need to provide short-term liquidity in its investments, which is one of the key advantages of a closed-end fund.

The Fund’s Board of Directors, in addition to overseeing the manager's strong relative investment performance, is also focused on the market price. For instance, early this year the Board announced two tender offers to provide liquidity and to address the discount, one of which has been completed. These actions followed an open-market share repurchase program instituted in 1997 and a managed distribution policy implemented in 1998. The discount now has lessened considerably and stood at 11.20% on January 10, 2003. This amount is within the range of those experienced by the Fund's Lipper peer group.

The Board of Directors of the Templeton Dragon Fund has informed Franklin Templeton that it also strongly opposes the Harvard College President and Fellows' proposal to terminate the Fund's investment management agreement and remains committed to pursuing the best interests of all of the Fund's shareholders in accordance with the Fund's stated investment objective.

Templeton Dragon Fund intends to file relevant materials with the U.S. Securities and Exchange Commission ("SEC"), including a proxy statement. Because those documents contain important information, shareholders of Templeton Dragon Fund are urged to read them, when they become available. When filed with the SEC, they will be available for free at the SEC's web site ( Shareholders can also obtain copies of these documents and other related documents, when available, for free by calling Templeton Dragon Fund at (800) 342-5236.

Templeton Dragon Fund, its directors and executive officers and certain other persons, may be deemed to be participants in Templeton Dragon Fund's solicitation of proxies from its shareholders. Information about the directors is set forth in the proxy statement for Templeton Dragon Fund's 2002 annual meeting of shareholders.

Shareholders may obtain additional information regarding the interests of the participants by reading the proxy statement of Templeton Dragon Fund when it becomes available.

Contact: Lisa Gallegos
Franklin Templeton Investments
Tel: 650-312-3395

The Scott Letter will have an interview with Mark Mobius, President and Portfolio manager of Templeton Dragon Fund and other closed-end equity funds in the February issue of The Scott Letter.

Directors’ Conference Focuses on
Corporate Governance Reforms

The 2002 Investment Company Directors Conference, which I attended last year because of my affiliation with Bergstrom Capital, focused on the effects on investment companies of significant new accounting and corporate reform measures, particularly those resulting from the enactment of the Sarbanes-Oxley Act of 2002.

Institute President, Matthew Fink, in his opening remarks at the conference, praised the fund industry for its commitment to core principles that have shielded funds from the scandals that have befallen other sectors of the financial services industry and led to a spate of legislative and regulatory initiatives including the Sarbanes-Oxley legislation.

“Like others in the financial services sector, we have grown. But unlike some others, we have not abandoned our core principles in the process,“ Fink remarked. “Of course, we have all felt the pain of the market decline, but the fund industry has not been stung by the ethical lapses that have tarnished some corporate entities. The mutual fund industry’s integrity and loyalty to shareholders have remained strong.”

Fink noted, however, that the industry’s “clean record and strong system of governance have not been enough to shield us in the current environment where legislators and regulators feel the need to do something, even if it is wrong. Efforts to address corporate ills on Capitol Hill have been hastily drafted and have inadvertently snagged the fund industry. Though well-intentioned, these efforts do not always fit the fund model. You and the management companies with which you work will be forced to bend and strain to make them work.”

Sarbanes-Oxley also contains provisions directly affecting the role of the audit committee. Many of these provisions are found in section 301 and apply only to listed companies, which includes most closed-end funds. According to Diane Ambler, Partner Kirkpatrick & Lockhart LLP the Sarbanes-Oxley Act “strengthens the audit committee’s role and reinforces fund management’s responsibilities with regard to financial statements.”

Some Closed-End Funds Issue Rights Offerings,
Drawing Criticism

An old practice that has drawn the ire of shareholders is getting renewed attention in the world of closed-end funds, according to a report in the Wall Street Journal. This is the practice of rights offerings, a way for funds to raise money from investors. For a while, because of shareholder criticism, it looked as if such offerings were going the way of the dinosaur, but recently more funds have revived the practice. Through rights offerings, closed-end funds can increase the number of shares by giving existing shareholders the right to buy new shares at a lower price than they could in the market.

When a fund issues shares, the stake of existing shares is reduced, and there will be dilution if the fund trades at a discount to its net asset value.

“For the investor, that can mean having to buy more shares just to stay even,” says Eric Jacobson, an analyst at Morningstar Inc. “You have to hope that whoever is managing the process is doing it with the shareholders’ best interest, but in the history of closed-end funds, there have been very few such situations.”

The dilutive effect of rights offerings doesn’t automatically hurt a fund’s share price, although the news of such an offering frequently sends fund prices tumbling. Those invested in funds making offerings are stuck with the choices of buying more shares, selling their holdings or suffering dilution if the fund trades at a discount. If the shares are in an IRA or other tax-deferred account, it may also be impossible to add cash to the account. Fund managers are the ones who stand to gain from rights offerings. One study estimates that during a ten-year period ending 1998, rights offerings increased advisory fees by an average of nearly 24%.

What should closed-end fund investors to do? We check to see if the fund has a history of rights offerings, and, if they do, is there much dilution? The Royce closed-end funds, for instance, have small rights offerings every year, but the dilution is minimal.

Fortunately, for closed-end fund investors, rights offerings that are highly dilutive are still rare. The deeper the discount, the steeper the dilution.

Take On the Street: What Wall Street and Corporate America
Don’t Want You to Know
by Arthur Levitt, with Paula Dwyer

Arthur Levitt, the longest-serving SEC chairman who supervised stock markets during the 1990s dot-com boom was instrumental in making changes to protect investors. His clearly-written 338-page book (New York. Pantheon, 2002) tells us of the former SEC Chairman’s crusade for greater transparency and disclosure. He sees individual investors, which number about 79 million, as “the most overlooked and underrepresented interest group in America”.

In the wake of the last decade’s rush to invest by millions of households and Wall Street’s obsession with short-term performance, a culture of gamesmanship has grown among corporate management, financial analysts, brokers and fund managers, making it hard to tell financial fantasy from reality, salesmanship from hard advice, according to Levitt.

The book shows you how to take matters into your own hands: the relationship between broker compensation and your trading account; the conflicts of interest inherent in buy-hold-sell recommendations of analysts; what actually happens when you place an order; the vagaries and vicissitudes of 401k investments; how accountants engage in slight of hand to fake impressive company performance; how to find the truth in a company’s financial statements and how stock options work; the real reason for the Street’s hostility to full disclosure and the crisis of corporate governance (this alone could be the subject of a book) and other topics of vital interest to investors including understanding how mutual funds often work against the interests of their shareholders.

The author outlines steps you can take to safeguard your financial future, including a primer on the how the capital markets really work. Levitt gives essential advice on a discipline we often ignore to our peril—how not to lose money. Many web sites are listed throughout the book so the reader can search for answers to the important questions affecting how to invest his money wisely.

This review will focus on what is essential to fund investors: the seven deadly sins of mutual funds. The investor will be able to contrast this section with how closed-end funds operate, seeing the advantages of the original form of investment fund. Levitt, who was once a partner of a brokerage firm and later President of the American Stock Exchange, starts out by telling us how, when he joined the Securities and Exchange Commission in 1993, he had to sell his stocks and bonds to avoid any conflicts of interest. When he decided to put his money into mutual funds, he found that the prospectuses were embarrassing. “If someone with 25 years in the securities business couldn’t decipher the jargon, how could the average investor do it?” He soon learned that this was one of the troubling practices of the mutual fund industry — an industry whose assets grew from $1.6 trillion in 1993 to over $6.6 trillion in 2001 in more than 8300 funds. This exceeds over $6 trillion in bank accounts.

A summary of what Levitt sees are the seven deadly sins of the mutual fund industry follows:

1.   High fees strangle returns. Even though they average 1.38%, high fees can dramatically reduce your returns over time despite the efforts of the industry to downplay the fee controversy. How much fund managers earn is not yet revealed.
2.The tax trap. Unless your money is in a tax-deferred retirement fund, you not only have to pay taxes on the mutual funds capital gains, but you may have to pay taxes when your fund loses money.
3.Kickbacks, Compensation, and Clunkers. Some fund operations are less than transparent. Soft dollars are a form of “legal kickback” which funds prefer to keep secret. Whenever a portfolio manager buys or sells a stock, she has to pay a commission. The conflict comes when the fund is willing to pay a higher commission to a full service broker because the fund gets a “rebate” in the form of soft dollars which are used to pay for research, software, and even computer equipment. You pay for this, and the numbers are substantial. The SEC estimates that soft dollar deals exceeded $1 billion in recent years.
4.The Fourth Deadly Sin is what Levitt calls “the fund industry’s dirty little secret”: most actively managed funds never do as well as their benchmark, or baskets of stocks or bonds that the fund adviser chooses as a performance yardstick. In 2001, 47% of domestic stock funds did not perform as well as the S&P 500 Index, according to Morningstar, even though the S&P lost 13.4%. And 2001 was one of the better years for managed funds.
5.The Culture of Performance. The Fifth Deadly Sin, and a close cousin to Number Four, is that a mutual fund’s past performance doesn’t predict future performance. The industry irresponsibly promotes this “culture of performance” even though it knows perfectly well that it misleads investors. “When it comes to mutual funds, the past is not prologue.”
6.Practice What You Preach. Most funds say they believe in the merits of long-term investing, lecturing their shareholders to stay invested in their funds, preferably ten to twenty years. However, the typical mutual fund manager sells every stock in her portfolio at least once a year. If a company misses its quarterly earnings estimate, out goes the stock, even if long-term prospects are good.
7.The Seventh Deadly Sin is that you can’t judge a fund by its name as many have names that are misleading, some downright deceptive. In the 1990s stock bubble, some portfolio managers took advantage of investors penchant by slapping “Internet” in front of fund names. As of 2002, the SEC now requires funds to have at least 80% of its assets in the securities that their fund name implies, up from 65% previously. This is one of the reforms of the Sarbanes-Oxley Act as well as the efforts of others interested in investor advocacy. This includes two House Democrats, Representatives John Dingell of Michigan and Ed Markey of  Massachusettes, who strongly supported Levitt’s efforts for better disclosure of mutual fund fees, greater bond fund transparency, getting rid of corrupt practices in the municipal bond business and improving auditor independence. “Dingel and Markey are instinctively pro-investor,” Levitt tells his readers.

The industry has been engaged in a lengthy debate over whether the SEC should require more frequent disclosure of a fund’s portfolio holdings. Currently, funds must reveal holdings twice a year in shareholder reports. While at the SEC, Levitt agreed with the industry’s point of view that more frequent disclosure would drive up fees and most shareholders would pay little attention. More frequent disclosure might help some funds keep closer tabs on their fund, and monthly disclosure also could actually hurt funds by revealing their strategies to front runners, professional traders who buy shares ahead of a fund in an effort to profit from the sale of shares once a fund’s bidding pushes the share price up.

Levitt is convinced disclosure at the end of every month, possibly with a 60-day lag so funds won’t be hurt by front running, makes sense. Monthly disclosure helps investors know whether their funds are following the investment strategy they signed-up for, and financial planners would know if their clients are properly diversified.

He discussed the relative choices mutual fund investors have in purchasing load funds with A, B, and C classes of funds, each of which carries different sales charges, depending on how quickly and easily you want to withdraw all your money. Investors in Class A shares pay up-front fees of 55 (or more!) at the time of purchase. Most Class A shares also charge a low annual marketing fee of 0.25%. Class B shareholders pay no up-front fee but instead pay an annual marketing fee of about 1%. After six or so years, Class B shares convert to A shares and pay the lower annual fee. Brokers like to recommend Class B shares because, they tell clients, there is no up-front fee. But B shares are more expensive in the long run, and some investors are better off buying A shares. With Class C shares, fund companies are experimenting with all kinds of fee structures to protect themselves from investors who jump in and out of funds.

He advises his readers to be smart mutual fund investors by paying attention to fees and expenses. He says some no-load funds which have lower expense ratios than most mutual funds charge an “exit fee” when you sell your shares, some charge 12b-1 fees (for marketing expenses) but it can’t exceed 0.25% of assets or the fund loses its right to call itself a no-load fund.

What surprised me is that Levitt never mentions the virtues of closed-end funds, which can more easily take a longer-term view, have much lower expense ratios, and  no 12b1 fees as they can’t advertise because they are listed stocks. Closed-end funds, of course, provide the investor the opportunity to buy shares at a discount to NAV which is impossible to do with mutual funds.

All this must seem to be both a revelation and a confusion to present mutual fund investors. Levitt is optimistic, however, that the reforms he discusses will eventually be enacted, especially if small shareholders contact lawmakers who can enact legislation favorable to their interests. In view of the current debate over “class warfare” over tax cuts and favorable tax treatment of dividends, Levitt’s book points out that the typical stock owner has a household income of $60,000 and total assets of $85,000, “not exactly the country club set” but a new investor class. Levitt decided that one of his goals as SEC Chairmen was to give voice to this new silent majority. Let’s hope his successors will continue this mission.

We highly recommend that every investor read this informative book and take some of the actions the author recommends to become smarter investors. It is available at at a 30% discount or $17.47 at the time of this writing.

Investors with Too Much Cash in Bond Funds
Could Get Whipsawed by Interest Rate Rise

Through November, stock funds had nearly $20 billion in net mutual fund redemptions, while taxable and municipal bond funds attracted  $134 billion in new money. If this continues, these investors may be taking big risks because of the possibility of rising interest rates later this year. According to Eric Jacobson, who heads up bond research at Morningstar Inc. in Chicago, “the biggest risk today for bond investors is rising interest rates. I don’t know that people fully realize that or are prepared for it. I worry about it quite a bit. I really fear that the high cash flows to bond funds will be a contrarian indicator. My biggest concern is that people will not only get burned by rising interest rates, but missing out on a stock rally will also burn them.

We mention this risk as at Closed-End Fund Advisors we have found that many of our older clients want more exposure to bond funds at a time when they ought to look at equities again rather than be placing too much emphasis on the bond market. This is what happened after the 1987 stock market crash at precisely the wrong time (and expanded the bond fund industry dramatically at a time when the great Bull Market of the 1990s was just getting started).

If our clients want to be in the bond market, we are very careful to put them in segments that have less interest rate risk such as term trusts and/or foreign government bond funds. Foreign interest rates, which are still at high levels, are poised to drop. As John Bowling points out at the beginning of this Letter, “In the long-run, stocks have produced an annual rate of return that is twice as large as fixed income investments.”

When retired investors tell us that they need a certain amount of income, we are able to provide it for them. We use both the fixed income as well as the equity markets and special situations that pay out a lot of cash. The bottom line is that when there is a larger amount of capital, there will be more money to generate income over time through careful diversification without taking too much risk.

Investment News & Notes

The Boards of Directors of Adams Express Co. (ADX-NYSE) and Petroleum & Resources (PEO-NYSE) announced in early December that they each voted to extend their respective share repurchase programs up to 5% of the outstanding shares over the next 12 months.

Bergstrom Capital (BEM-AMEX): For Immediate Release. Seattle, Washington – January 16, 2003 – On March 15, 2002, Bergstrom Capital Corporation (the “Company”) reported that its Board of Directors had commenced a search for a tax-free merger or other business combination with a larger registered investment company. The Board decided to take this action in view of the relatively small size of the Company and the increasing expense and effort required to operate it.  In addition, members of the Board, including the Chairman and the President of the Company, had indicated their desire to pursue other interests. If an appropriate combination could not be achieved, the Board said that it would consider other alternatives, including the liquidation of the Company.

After an unsuccessful search for a suitable merger partner, the Board of Directors voted unanimously today to liquidate the Company, subject to the approval of the Company’s stockholders. A proposal to liquidate the Company will be submitted to stockholders for their approval at a meeting of the Company's stockholders currently scheduled for March 2003.  Proxy materials describing the plan of liquidation will be mailed to stockholders in advance of the meeting. A vote of two-thirds of the outstanding shares in favor of  the liquidation is required.

In order to preserve the Company’s flexibility in structuring a possible transaction, the Board of Directors had instructed the Company’s investment adviser to refrain from making new equity investments. As a result, the value of the Company’s holdings in cash equivalents and other short-term investments has increased to 22.9% of the Company’s total investments as of January 15, 2003. In anticipation of liquidation the Board has further instructed the Company's investment advisor to commence an orderly sale of the Company's remaining equity positions. If stockholders approve the liquidation, the Company will make cash distributions of all its assets to stockholders, after providing for the expenses of liquidation and any other liabilities.

The Board and staff of the Company are deeply saddened that our friend and colleague, Norman R. Nielsen, a director of the Company since 1976, died on December 25, 2002. The Board of Directors is very grateful to Mr. Nielsen for his dedication and excellent service to the Company and its stockholders over the years. On January 8, 2003, the Board elected Robert A. Brine to succeed Mr. Nielsen.

The Company is a closed-end, non-diversified investment company whose principal investment objective was long-term capital appreciation, primarily through investment in equity securities. The Company’s shares are traded on the American Stock Exchange under the symbol BEM. For further information, contact William L. McQueen, President of the Company, at (206) 676-1148.

BlackRock Advisors, Inc. registered 100,000 common shares of closed-end BlackRock Partners Trust. The firm will offer the shares for $15.00 each. The fund seeks total return through a combination of current income and capital appreciation. The fund intends to initially invest about half of its assets in equity securities and the remainder in income securities. BlackRock Advisors and sub-advisor, Wellington Management Co. LLP will re-allocate the net assets periodically between income securities and seek superior risk-adjusted returns.

BlackRock Advisors, Wilmington, Delaware, is a wholly-owned subsidiary of BlackRock, Inc(BLK). BlackRock Inc has nearly $250 billion of assets under management and is a member of PNC Financial Services Group (PNC).

We do not recommend that our readers participate in the initial offering of this fund but consider it later when the fund may trade at a discount after the underwriting fees have been absorbed.

“Fatigue is often caused not by work, but by worry, frustration, and resentment. We rarely get tired when we are doing something interesting and exciting.” — Dale Carnegie

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