Explaining Premiums And Discounts On Closed‐End Equality Country Funds

Over the past decade or so, the surge of interest among U.S. investors in international investing has led to the creation of numerous foreign equity country funds. Like U.S. closed‐end mutual funds, the prices of such closed‐end country funds fluctuate widely in relation to their underlying net asset values (NAVs). In this paper, the authors summarize the major findings of their recent study of the performance of 28 country funds relative to their NAVs over the period 1978–1995. While 20 of the 28 funds traded at average discounts to their net asset values, the discounts for the country funds were smaller than those of the average U.S. fund, and over a quarter of the funds sold at premiums. In an attempt to explain such premiums or discounts, the authors examined primarily three factors: (1) the sensitivity of country‐fund returns (relative to that of local market indices) to U.S. returns; (2) the possible effects of local government investment restrictions; and (3) the impact of exchange rate changes. Although most of the eight funds that traded at average premiums represented countries with significant restrictions on capital flows and foreign ownership, there were also a number of funds with similar restrictions trading at significant discounts. In exploring the reasons for such discounts, the authors noted that the returns to the country funds were “surprisingly sensitive” to U.S. market conditions, thus reducing the extent of their diversification benefits for U.S. investors. The article also raises the possibility that if such country funds are not “priced at the margin” by globally diversified investors, U.S investors' “country‐risk sentiments” could cause such funds to trade at discounts.