Are initiators' forecasts of German closed-end funds biased?

Objectives: Closed-end fund investors face several obstacles both when deciding to invest in this type of funds and after having added a closed-end fund to their investment portfolio. Compared to open-end mutual funds, closed-end funds provide less information about the investment strategy, they are barely diversified or even single project-based, and the secondary market is largely illiquid. Despite these obstacles, an investment in closed-end funds might be of interest for a number of investors who intend to engage in entrepreneurial activity. In this paper, we analyze whether project forecasts provided by closed-end fund initiators adequately inform investors. Specifically, we examine four main research questions. First, is there a bias in the forecasts issued by closed-end funds initiators? Second, is the initiators' forecast bias predictable, i.e., is there persistence in the forecast bias of initiators? Third, which initiator and fund characteristics influence the initiators' forecast bias? And fourth, do secondary market participants adjust their implicit cost of capital estimates to reflect the initiators' forecast bias and characteristics?

Data/Methods: We analyze to what extent actual cash distributions and cash flows to closed-end fund investors deviate from the projected figures. We base our analysis on a sample of 3,673 German closed-end funds in the period from 1972 to 2012. We conduct a series of univariate statistical analyses and of regression analyses in both a static and dynamic setting.

Results: The statistical analysis provides evidence of on-average optimistically biased initiators’ forecasts on cash distributions and cash flows. Specifically, we show that forecast optimism is pronounced in funds from initiators that are stock market-listed, and less severe in funds that are larger and set up by larger initiators. In addition, our results indicate that secondary closed-end fund markets are inefficient with respect to incorporating these predictable patterns into the market prices of fund shares.