At the New York Stock Exchange's opening bell today, Van Kampen Merritt Investment Advisory Corp. will launch two new closed-end municipal funds that have ruffled feathers throughout the dealer and brokerage communities.
The Chicago-based investment firm will raise $550 million for its Quality Municipal Trust and about $100 million for the Pennsylvania Quality Municipal Trust. Projected tax-exempt returns to investors are 7.25% and 6.75%, respectively.
The new funds break several rules, lowering the fees paid to both underwriters and retail salesman, but Van Kampen Merritt executives gathered yesterday at an analysts' briefing said the worst is over, and the market is now set to accept their maverick bond fund.
"There was a lot of holding the breath" when the funds were first marketed, said Stephen Hodgdon, senior vice president of new product development at Van Kampen Merritt. "It was an in-the-trenches kind of selling, but the story has spread like wildfire."
The story to underwriters is lower revenues. One of Van Kampen Merritt's innovations was to eliminate the traditional syndicate structure -- where Wall Street firms reap handsome fees for ensuring placement of the securities -- and assume all lead underwriting responsibilities. Several of the nation's largest underwriters pulled out of the 162-member selling group in protest.
Mr. Hodgdon said the companies declined to participate either for market-timing reasons or because of their own internal policies.
The risks of taking full responsibility for placing the securities include the possibility all shares will not be sold, and that the share price will fluctuate messily. Jack Merritt, president and chief executive officer of Van Kampen Merritt, said the funds can meet the stated goal of matching net asset value to stock price in two ways.
First, if the net asset value rises above the stock price by up to 1%, Mr. Merritt said, portfolio managers can use dividends to purchase up to 5% of the outstanding shares, helping to boost the share price and put it in line with net asset value. Second, if net asset values lag share prices -- as is the case with most closed-end funds -- the Van Kampen Merritt funds can sell more shares at the going price, simultaneously boosting net asset values and pressuring share prices.
The other major change is a reduction in retail brokers' commissions -- by about 35% -- and the removal of the commission from the share price. To date, other closed-end sponsors have incorporated the broker's fee into the price paid, contributing to a portfolio net asset value that is lower than the stock price.
The "selling penalty" structure, a disincentive for brokers mulling whether to move their clients out of the stocks soon after an initial offering, remains in the new Van Kampen Merritt funds.
The firm's strategy by reducing two well-established fees is to pass more tax-exempt income on to the individual investors. If yields pan out as expected, the firm should succeed. Several analysts at the Van Kampeon Merritt briefing were optimistic about the entire structure.
Yesterday, Nuveen priced a New York closed-end fund with an expected yield of about 6.05% and a California fund with a yield of about 6.15%, raising more than $620 million. The anticipated yields on Van Kampeon Merritt's new New York fund is 6.65% and its new California fund is projected at 6.25%.
Brokers yesterday said the interest in all closed-end funds remains incredibly strong, but noted that today's reception of the Van Kampen Merritt funds will be the start of the real acid test.
"It may work out great," said Doug Culver, syndicate coordinator at Prudential Securities Inc. "But I'd still like to see the aftermarket before I actually commit my customers money to it."
All of the six planned Van Kampen Merritt funds will use preferred shares to leverage the existing portfolios. The new national fund will issue short-term preferred shares in four tranches -- two seven-day floating issues and two 28-day floating issues.
David Johnson, portfolio manager at the firm, said there is a strong possibility that short-term tax-exempt rates will decline in the near future, which would boost yields to the close-end investors by lowering borrowing costs.
Asked what would happen to investors' yields if short-term rates increased, Mr. Johnson said, "We're building cushions at this time in all of the funds."
