The unitholders of OpenSky Capital Income Fund, a closed-end fund trading on the Toronto Stock Exchange, have voted to wind up and liquidate the fund due to poor returns and dwindling assets.

Since the fund was launched about three years ago, its average annual compound return on net asset value has been 9.5%. It has usually traded at a discount to NAV, however, and this may have further aggravated investors’ losses.

Assets have fallen to about $8 million from the initial $31 million, says Serge Fecteau, senior vice president at OpenSky: “It didn’t make sense to continue with the fund. As the assets declined, expenses were taking a big bite out of the income being generated by the fund. The fund is too small to run profitably.”

Like many closed-end funds launched during the past few years, OpenSky Capital Income Fund was designed as a vehicle to pay regular income to its investors. Its holdings have been invested in a diversified portfolio of income trusts, equally divided among four main sectors: business trusts, oil and gas, real estate and utilities.

The fund has been affected not only by the performance of its income trust holdings but also by a tendency of investors to redeem during the annual window of opportunity the fund offers. At that time, investors can cash out at NAV rather than having to sell their units on the stock exchange.

Many closed-end funds that offer a similar annual NAV redemption window have been affected by investors and sophisticated arbitrageurs who buy up units at a discount to NAV on the stock exchange, then later redeem the units from the manager at full NAV. This practice results in a significant reduction in the size of the fund’s asset pool, making it difficult to manage the fund profitably, often leading to a further depression of the market for the remaining fund units.

“It’s like a cat chasing its tail,” says Fecteau. “The more redemptions there are, the more costs escalate as a percentage of the assets, and the more difficult it becomes to achieve a positive return.”

The ability of investors to redeem at NAV has been a problem for several closed-end funds trading at a discount to NAV, Fecteau says. And because OpenSky was a small fund from the outset, it was more vulnerable. The “inflection point” — when it simply becomes too costly to manage a closed-end fund — is around $15 million in assets, he says. With annual costs of up to $300,000 a year, the expenses are “out of proportion” for funds with fewer assets, he adds.

“While mutual funds can always be purchased and redeemed at NAV, the value of units in closed-end funds is also affected by supply and demand on the stock market,” says Mark Chow, senior analyst at fund analysis firm Morningstar Canada in Toronto. “Closed-end funds can trade at a premium or a discount to NAV, and often arbitrageurs get involved if they see an opportunity to profit from the trade.”

OpenSky’s portfolio is being liquidated. Once all liabilities are discharged, the remaining assets will be distributed in cash to unitholders. The final distribution is expected to take place by June 30.

OpenSky has participated in the development of about $2.5 billion worth of structured and alternative products, including principal-protected notes and closed-end funds.

It is owned by Quanto Financial Group, a private company whose principal shareholders are Deutsche Bank, National Bank Financial Ltd. and Redfern Equity Capital Partners, a Montreal-based private-equity firm. IE