Lingering issues with auction-rate preferred shares, which many investors are stuck with a year and a half after the auction system froze, are seen as hindering the closed-end fund industry's ability to launch offerings.


Banks and brokerages redeemed many investors' shares in settlements with regulators. "Nevertheless, the ARPs process is still 'broken' and the lingering problem has, in many ways, held back growth in the industry," said a report from Thomas J. Herzfeld Advisors, a Miami investment-advisory firm.


Income-seeking investors are buying closed-end funds at historically narrow discounts, many with leverage. Some unleveraged funds are trading at discounts and may be a better value for investors willing to give up some current income in exchange for less downside risk, said Cecilia Gondor, vice president at Herzfeld.


Closed-end fund providers have been shedding some leverage and shifting to other forms such as tender-option bonds and new types of securities, but the credit crisis has hamstrung those efforts. About 70% of closed-end funds are using some form of leverage, and 67% of those still have some auction-rate preferred shares outstanding, according to Herzfeld.


Tender-option bonds, which are derivative securities created from fixed-rate bonds through a trust arrangement, have been one popular substitute, but use is limited because bonds must be of high quality. New types of preferred shares, with alternative forms of financing, also are being used.


Nuveen Investments, which used about $1.8 billion in tender-option bonds to replace auction-rate securities, issued another $500 million in variable-rate demand-preferred shares for four of its funds in August 2008. It said that move was successful.


While it is less challenging now than six to nine months ago to find refinancing partners, the cost of funding relative to the cost of leverage is an issue. Replacing auction-rate shares with new securities, such as the liquidity-enhanced adjustable-rate securities that BlackRock has proposed, would cost significantly more. So fund companies continue to use tender-option bonds to refinance at the margins.


Fixed-rate preferreds and the new floating-rate preferreds represent less than 5% of the leveraged closed-end fund market, according to Herzfeld.


BlackRock has redeemed $2.1 billion of the $8.2 billion in auction-rate securities issued by its municipal funds, replacing most of them using tender-option bonds. It has redeemed $1.09 billion of the $1.6 billion in auction-rate securities issued by its taxable closed-end funds.


Allianz's Pacific Investment Management has redeemed $1.9 billion of the $4.28 billion in auction-rate securities its closed-end funds had outstanding, the company said. It declined to comment further.


Of the $5 billion Eaton Vance had outstanding when auctions failed in February 2008, it had redeemed $3.8 billion by the end of that year. Progress has been slowed by difficulties finding alternative financing and the low rates at which the outstanding shares are resetting in failed auctions, a spokeswoman said.


Nuveen plans to have all of the auction-rate preferred shares issued by its taxable funds refinanced by Friday. But it still has about $8.7 billion in auction-rate preferred shares outstanding.