Van Kampen Merritt Inc. is breaking new ground in the closed-end bond fund world by selling municipal funds without the help of an underwriting syndicate and lowering brokers' commissions.
The Chicago-based firm is hoping to turn out publicly traded securities with superior yields: The underwriting and brokerage fees, essentially, are plowed back into the funds.
Stephen Hodgdon, senior vice president of marketing at Van Kampen Merritt, said the target tax-exempt yield for the new national fund is 7.25% to 7.40%. The Bond Buyer's Municipal Bond Index, by comparison, is at an all-time low of 6.92%.
On Friday, Van Kampen concluded the underwriting period for six new closed-end funds -- The Van Kampen Merritt Municipal Trust, a national fund; and five single-state series by the same name for investors in California, New York, Florida, Pennsylvania, and Ohio. Instead of signing on a group of high-powered national and regional retail brokerage outfits. Van Kampen chose to sell the funds on the strength of the firm's name alone.
"We are the only underwriter," Mr. Hodgdon said. "Nobody is giving us a firm commitment to sell the shares."
Normally, syndicate members promise to sell shares of closed-end funds for a commission or "take-down" of 6% to 7%. Van Kampen is going out on a limb with a selling group of about 156 firms, none of which are obligated to sell the shares.
Mr. Hodgdon said Van Kampen expects to make less on the new funds because it isn't paying itself a takedown either. Market wisdom says Van Kampen is setting itself up for a fall caused by "after-market" risk, or the possibility that the firm will have to eat its own product.
Mr. Hodgdon said Van Kampen is betting on the attractiveness of the product. "The shares will get sold because the structre is extremely beneficial to the shareholders," he said. "It puts 100 cents of the client's dollar to work."
Market sources said the new structure caused many traditional underwriters to bristle because, if the structure catches on, significant fees could go down the drain. And at least four firms declined to sell the new funds altogether, they said.
Mr. Hodgdon countered that the market had accepted the funds widely, with a number of selling group members exhibiting "tremendous patience," despite the new and unusual structure of the securities.
The other major new feature is the removal of brokers' commissions from the funds' share prices. Until now, all closed-end fund sponsors included the selling brokers' incentive in the price, and the structure included an artificial mechanism whereby brokers would lose the commission if investors "flipped" out of the stock too soon.
With the new funds, brokers are paid a smaller commission directly from Van Kampen Merritt. Mr. Hodgdon estimated brokers would receive 30% to 40% less than they would with traditional closed-end funds, yet he did not anticipate the lower compensation would hurt sales efforts.
"We are surprised at how quickly it was received," he said. "We thought there would be more rigidity than we actually received."
As with other closer-end funds, Van Kampen will leverage this new breed through the sale of preferred shares about 30-days after the shares are freed to trade on the exchanges. At the latest, the funds will be listen in the first week of December.
Van Kampen expects all of the first six to trade on the New York Stock Exchange, but Mr. Hodgdon could not confirm the fact because stock sizes had not yet been determined. "We're still taking a body count right now," he said.
