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May 3, 2004, 12:01 a.m. EDT

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By Lawrence C. Strauss

Meanwhile, Margolin is steering clients away from the leveraged municipal funds he covers, concerned about their sensitivity to interest-rate increases. He prefers funds that have assets in more than one sector and that use floating-rate senior loans, a tool to hedge against rising rates.

One fund Margolin recommends is Putnam Master Intermediate Income Trust /zigman2/quotes/204643321/composite PIM -1.80% , which does not use leverage and which has a relatively short average duration of 3.52 years, according to Morningstar. Sporting a 7.3% yield last week, the fund traded at about a 12% discount to its net asset value. "That's an opportunity, in our view," he says. "The discount is significantly deeper than it traded at historically."

Another fund Margolin favors is the Eaton Vance Limited Duration Income Fund /zigman2/quotes/201497040/composite EVV -2.55% , which traded at about an 8% discount last week, with a yield of 9.2%. Launched nearly a year ago, the fund has a duration of just over three years. While it is leveraged, the fund holds floating-rate senior loans.

Adams of Nuveen maintains it is important for an investor to think about closed-end funds as part of a larger portfolio strategy built on asset allocation.

"Investors need to form an opinion of how much they're going to allocate to fixed income, what their views are about interest rates and how quickly they think interest rates may rise," says Adams. "Then they need to do some homework on each fund -- what the duration is, what the dividend quality is and whether it will be able to sustain the dividend if rates go up." Adds Adams, "Know what you own and why you own it."

In this market, with all the new money that's been poured into closed-end bond funds, that's not a bad starting point.

Transparent Funds

In this era of mutual-fund reform, it remains unclear whether investors will emerge with a clearer sense of the transaction costs they pay.

Under the current system, those costs typically aren't disclosed in terms of basis points or as a percentage of a fund's assets. Funds are required to reveal the amount they pay annually in brokerage commissions, but that doesn't give investors much context, says Don Cassidy, a senior research analyst at Lipper, and it is not always easy to find. A fund adviser can put this information in an annual report, a proxy statement or a statement of additional information. "So, happy hunting!" as Cassidy puts it.

Transaction costs, of course, involve more than brokerage commissions. In addition, there are bid-ask spreads, market-impact costs (which occur when, for example, a fund manager buys a big position in a stock, pushing up the price) and tax implications, such as when a fund realizes a big capital gain in a stock it sells. Getting a handle on all of those costs is difficult, however.

Cassidy points out that portfolio-turnover ratios often, though not always, provide a good clue of a fund's trading costs. A better indicator of transaction costs, Cassidy argues, would be a ratio reflecting what's paid for brokerage commissions -- Fund A's commissions cost 25 basis last year, for example. (Or it could be represented as a percentage of assets.) Currently, whatever a fund adviser pays for commissions is deducted from the fund's net asset value, preventing the investor from easily determining how much that expense ate into returns.

What's more, Cassidy maintains, it would make sense for a management company to prominently publish two ratios, one reflecting total expenses (including commission costs) and the other showing the annual bill for brokerage commissions, either in basis points or as a percentage of assets.

Lipper estimates that in actively managed equity funds, the drag on performance from brokerage commissions is about 20 basis points annually on a dollar-weighted basis. "It is extremely clear that investors who rely on 'the total expense ratio' are seeing only part of the full picture," Cassidy explains. And those costs should be displayed in the annual report and the prospectus, he says.

The Investment Company Institute, which represents the mutual-fund industry, argues that if a fund has unusually high commission costs, it will show up in the returns, about which investors can make their own judgment. That is true, but a lot of retail investors don't have a clue about transaction costs, much less how to analyze them in relation to returns.

Among other measures, the ICI has proposed disclosing brokerage commissions as a percentage of a fund's average net assets, as well as expanding and displaying more prominently a fund's turnover ratio.

The ICI, however, opposes including brokerage commission costs in fund-fee tables or in total expense ratios, maintaining that it "would diminish the ability of investors to use this information to compare the cost of different funds."

The Securities and Exchange Commission has not yet taken any action.

E-mail comments to editors@barrons.com
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