With few options on US stocks to bet on Russian assets, investors have rushed into a small closed-end fund that tracks Eastern European stocks.
Trading volume in the $51 million Central and Eastern Europe Fund (CEE ticker) managed by DWS Group soared in recent weeks after major Russia-focused exchange-traded funds were halted. Nearly 1.4 million shares were traded during the week ending March 18 amid news of Russia-Ukraine peace talks, the highest weekly trading volume since 2006, according to data compiled by Bloomberg.
Accumulating in CEE does not come without risks, and not everything is geopolitical. Closed-end funds, unlike ETFs, issue a fixed number of shares, so their trading price can quickly diverge from their underlying assets as demand for the stock changes. CEE traded at a nearly 24% premium on Thursday, the highest on record for a fund that typically trades below the value of its underlying assets, making it difficult to use the fund as a tool to closely monitor Russian stocks. And most of the fund’s Russia-linked securities are depository receipts, which are still sitting on exchanges and therefore difficult to value.
“There was nowhere to trade, no one could place bets on Russia, no one could hedge their exposure, so a lot of people came here,” said James Seyffart, an ETF analyst at Bloomberg Intelligence. But, he warned, “anyone marketing these things is playing with fire right now.”
Since closed-end funds aren’t required to report holdings on a daily basis, investors don’t know what they’re holding in real time and may not understand how they value their assets.
Roughly 60% of CEE’s holdings were in Russia-linked securities, as of February 24, the disclosures show. By March 14, they had virtually zeroed out the entire allocation. While Alrosa PJSC, the only local Russian stock owned by the fund, resumed trading this week in Moscow, the remaining Russia-linked securities were depository receipts.
The securities are given “fair value” if their market prices are not available, which for CEE is the amount it “could reasonably expect to receive for value at its current sale,” DWS said in a statement. But any valuation assigned to Russian CEE securities is “subject to change and can potentially be reduced to zero,” according to the firm. Such securities may actually be worth nothing if Russia is completely closed to foreign investors, Seyffart said. CEE does not plan to make new investments in Russian securities, the firm said.
Meanwhile, CEE is trading at a premium as demand for the fund likely outstripped the number of shares available, Seyffart added. Investors may want to play the Russian market or hedge against transactions they have in other Russia-linked securities that are frozen, he said. But these movements are risky, as “there is no guarantee that they will correlate with the price of the underlying assets.”
Russia-focused ETFs could also drive investors away from CEE, as long as they start trading again, said Todd Rosenbluth, head of research at ETF Trends. This could lead to less liquidity for the fund and make it harder for investors to exit their positions, he added.
Before the Russia-focused ETFs were halted, they suspended creation of shares, causing them to behave similarly to a closed-end fund. But such ETFs made purer bets in the country and offer more transparency than CEEs, Rosenbluth said.
“Investors’ comfort with ETFs has outpaced their comfort with using closed-end funds, so I think ETFs are more likely to win.”
–With the assistance of Emily Graffeo.