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

March 2003, Volume III, Issue 3
George Cole Scott, Editor

Completing the Checklist
by Charles Kadlec, Managing Director, J&W. Seligman & Co.
February 25, 2003

The world is fast approaching a moment of discontinuity, a schism that will forever separate the past from the future, the world as we have known it, and the world that will forever be different in its trajectory into the future…What makes the present so unusual is our awareness that the moment of discontinuity is about to occur, that the denoument with Iraq is likely to shape the rest of history in ways that will be far clearer in as little as six weeks.

Until now, many commentators have focused on the risks and potential downfalls of war or the avoidance of war with Iraq. While acknowledging those risks, this commentary offers a checklist for the opposite side of the page under the heading, "Possible positive developments that may occur over the next 12 to 18 months".

  • A dramatic reduction in the terrorist threat
  • Stability in the Middle East
  • A fall in oil prices to less than $25 a barrel
  • A resolution of the Korean crisis

Better Than Expected Economic Growth

The risks ahead are real and should not be minimized. War with Iraq could prove difficult and may inflame Arab volunteers to expand terrorist attacks on the U.S and its allies; US military forces could get bogged down in a hostile Iraq plagued by guerilla attacks; Iraqi oil fields could be damaged leading to $50 per barrel oil prices; key post-World War multilateral institutions, including the United Nations, NATO, the World Trade Organization, and the general commitment to a liberal world economic order, could be weakened because of the spilt between the US, and France and Germany. Such a trajectory could include a significant contraction in world economic trade and economic activity that could trigger an international financial crisis.

However, the potential positive developments ahead may also be real. Their enumeration is not a refutation of the dangers, but an identification of an alternative trajectory that would imply a significant expansion of world trade, economic activity, and the restoration of a positive environment for equity markets.

The recent spike in the price of oil has more to do with the disruption of oil production in Venezuela and a colder-than-average winter in North America than with the threat of war in the Middle East. None the less, the prospects for stable oil prices under $25 a barrel would improve the outlook for the US economy as well as the economies of all other oil-importing countries.

Advancing the tax cuts now scheduled to take place over the rest of the decade would act as an offset to the increased barriers to domestic commerce caused by the war on terrorism, leading to increased employment, output, and investment. Eliminating the double tax on corporate income would reduce the tax rate to 35% from the combined 60% rate today. This means that for every $1000 in pre-tax income, shareholders’ after-tax returns would increase to $650 from $400 — an extraordinary 62.5% increase in after-tax rate of return — as dollars earned are used to generate dividends now or in the future. Enactment of this proposal likely would lead to a surge of corporate activity, and, by reducing the tax barrier between management and owners, improved corporate governance as well.


In our view, observers, investors, commentators, and the general public have been focused on the near-term risks created by the confrontation with Iraq and warnings of another terrorist attack on the people of the United States. As a consequence, we believe that much of these risks are reflected in today’s equity prices. However, to the extent these dangers are avoided and the risks reduced, a more positive environment is likely to emerge. For example, the S&P 500 Index fell 14% from its average high before Pearl Harbor, the Korean War, and Iraq’s invasion of Kuwait. In the subsequent year, the S&P 500 rebounded on average 36%. That is why preparation for the investment environment that lies ahead requires having a checklist for both the negative and positive developments that may occur in the months ahead.

Closed-End Fund Conference Addresses Challenges, Initiatives
by Douglas G. Ober
Chairman of Adams Express Company and
     Petroleum & Resources Corporation
President of The Closed-End Fund Association

Leaders of the closed-end fund industry met at the New York Stock Exchange this month for the annual industry conference of the Closed-End Fund Association. Each year, the Association brings together executives of closed-end funds to review our progress in serving fund shareholders and address our challenges with renewed focus.

One triumph to celebrate was a recent high water mark in the issuance of closed-end funds last year, owing to the demand for fixed-income closed-end funds. Countering that success was the decline in closed-end analyst coverage by Wall Street, including the discontinuation of industry coverage by Merrill Lynch, a development that generated more calls to the Association than any other topic this year.

A variety of industry observers and fund executives addressed issues ranging from the competitive landscape and industry trends, to strategies for addressing closed-end fund coverage and distribution strategy.

Don Cassidy, noted Senior Eesearch Analyst at Lipper, Inc., provided an incisive view of trends and observations of the industry. Fund performance was often better than some believe, he said, and more funds should present their long-term performance in “mountain charts” and other illustrations that reinforce superior investment performance. Investors will remain risk averse, he predicted, and perhaps closed-end funds can meet with a variety of product structures, including a balanced fund.

Avi Nachmany, Director of Research and Executive Vice-President of Strategic Insight, had some very interesting observations for our industry. He minimized the competition to open-and closed-end funds posed by Exchange-Traded Funds (ETFs), saying that ETFs were experiencing slow growth as an alternative to mutual funds. Favored more by institutional investors than retail investors, he said that perhaps only 10% of flows to ETFs can be attributed to retail investors.

Strategies for addressing closed-end coverage were offered by a panel moderated by Dr. Albert Fredman, Professor of Finance at California State University. The panel included Charles Kadlec, Managing Director of J&W Seligman, David Schachter, Vice President of Gabelli Funds, and Richard Strickler, Managing Director of Aberdeen Asset Management. The panel discussed engaging independent analysts to boost coverage of the industry, hosting online manager "chats" and developing communications materials that would aid financial advisors in marketing closed-end funds to their clients. There was much agreement that analysts can add value by attracting investors in general to closed-end funds and, in particular, to identifying value in the more complicated analysis of fixed-income funds.

Howard Schneider, a Marketing Consultant and Founder of Practical Perspectives offered several insights on navigating the advisor marketplace. He suggested that closed-end funds joint venture were asset management firms that could offer access to their network of distribution in exchange for the opportunity to manage some fund assets. But such access does not come cheap, he noted, adding that the cost of sales distribution is edging higher, as sales organizations seek to improve margins at the expense of product manufacturers.

The challenges for closed-end funds continue to be met with fresh approaches and new initiatives. I announced to the attendees that CEFA is putting together a working committee to pursue the initiatives raised at the conference and to work for improved analyst coverage to keep the merits of investing in closed-end funds visible to brokers, financial advisors and their clients.

Update on Central European Fund
The Germany Fund, Inc., The New Germany Fund, Inc., and
The Central European Fund. Inc.
280 Park Avenue, New York, N.Y. 10017
Tel: (212) 454-1695
February 28, 2003

Dear Fellow Investors,

Many of you have seen recent articles in the media about Central Europe and also about Russia. The Wall Street Journal published an article last fall entitled "Deutsche Bank Fund Focuses on Central Europe." More recently, Forbes published a piece on the same fund, The Central European Equity Fund, entitled "Central Europe continues its steady march to prosperity. It’s still not too late to get on board." Both of these stories as well as related articles are posted on the fund’s web site:

We believe that this fund, which showed a gain in net asset value of 17.05% in its last fiscal year (19.14% for calendar 2002) still shows interesting potential.

Central Europe and Russia are now capitalist countries without capital. It is flowing into them. Forbes reports that nearly $100 billion in foreign debt investment has flowed into Central Europe since the Iron Curtain fell. They believe this region of nearly 90 million people remains a compelling investment alternative to Western Europe and also the riskier emerging regions like Latin America. The key to Central Europe’s appeal, as well as Russia, explains Chief Investment Officer Hanspeter Ackermann, is an ideal blend of better growth and value. In fact, he believes the whole region is undervalued. With continued progress towards joining he European Union next year, the Central European economies should do well ...."

Richard T. Hal, President
Robert R. Gambee, Chief Operating Officer

Pioneering Portfolio Management:
An Unconventional Approach to Institutional Investment
by David F. Swensen
Chief Investment Officer, Yale University

This exceptionally readable book was written and published in the year 2000 by David Swensen. After a prior successful career on Wall Street, Mr. Swensen transformed the management of Yale University’s investment portfolio in the late 1980s and 1990s into a model for a disciplined approach to asset allocation. Swensen largely focuses on nonconventional strategies, including a heavy allocation to private equity. He has achieved an average annual return of 17.4% in the 14 years (1985-1999) and has managed the endowment. The assets of the university’s portfolio were transformed under his watch from $1 billion to $7 billion by the year 1999, bringing it into the top tier of institutional funds. During his career at Yale, Mr. Swensen relied little on bonds and almost entirely used nearly 100 outside managers, picked by his committee. In this book, he draws on his experience and deep knowledge of the financial markets to provide a comprehensive array of investment strategies.

The book also presents an overview of the investment world of institutional fund managers, pension fund fiduciaries, investment managers, and trustees of universities, museums, hospitals and foundations. Swensen offers penetrating insights from the broad issues of investment goals and philosophy to the strategic and tactical aspects of portfolio management. He also addresses important concepts such as handling risks, selecting investment advisers and negotiating the opportunities and pitfalls in individual asset classes, using real world examples.

At a time when it is becoming increasingly difficult to cope with the challenges in today’s financial markets, Swensen’s book is an indispensable roadmap for creating a successful investment program. We will review a portion of it which we feel applies to the average investor who may wish to read it on his own.

Swensen instructs his readers that successful investors are those who operate with a coherent investment philosophy and apply consistency to all aspects of portfolio management. "Once you rise to the level of enduring professional convictions," he says, "you have reached time-tested insights."

Asset Allocation

The first step is to understand what asset allocation really means. Swensen sees it it as the starting point for portfolio construction which involves defining the asset classes and determining the proportion of the portfolio to be invested in each class. He lists as typical asset classes: domestic equities, foreign equities, fixed income, real estate, private equities. He says, "asset allocation combines art and science in portfolio construction as either informed judgment or quantitative analysis which alone fails to produce consistently successful results. Seat-of-the-pants decisions lack rigor, omitting information valuable to the investment process. On the other end of the spectrum, a mechanistic application of quantitative tools produces naïve, sometime dangerous conclusions. Marrying the art of seasoned judgment with the science of numeric analysis creates a powerful approach to allocating portfolio assets."

Swenson says selecting asset classes is the initial step in producing a portfolio. He also feels strongly that investors should not rely on investing in assets popular at the time, a common fault. Many investors fail to consider the function of a particular asset in a portfolio that is designed to meet specific goals. Asset classes change over time, from the popularity of real estate in the 1850s, to bonds and notes and stocks popular at the time. He says in the 1950s, the university held domestic bonds, domestic common stocks, preferred stocks, and real estate. Investors need to begin by selecting asset classes that promise to meet fundamental investment goals; this can include domestic and foreign equities and, to mitigate equity risks, portfolios should include assets such as fixed income and real estate. "By understanding and articulating the role played by each asset class," he says, "investors avoid making allocations based on the fashion of the day."


"The fundamental objective of portfolio management lies in faithful implementation of long-term policy targets." This means that if investors allow the actual portfolio holdings to differ materially from asset class targets the portfolio then fails to reflect risk and return preferences as expressed through the asset allocation process. Once the initial asset allocations are established, the manager follows targets which require that the portfolio be rebalanced periodically, using proceeds from selling assets exhibiting relative strength to fund purchases of assets showing relative weakness. It is helpful to use low-cost, passive investment vehicles for this process. By a serious use of rebalancing, you are assured that you maintain target levels.

Still Buying Bonds

Mutual fund investors have continued to sell stock funds and buy bond funds this quarter, despite interest rates that have hovered at the lowest levels since the 1950s. — Wall Street Journal.

Note: The April Scott Letter will feature an interview with Douglas Ober, Chairman and CEO of Adams Express and Petroleum & Resources funds.

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