Over the last few weeks, a couple of warning flags have popped up that reminded me that with closed-end funds and structured products, it’s ‘buyer beware’.

The first flag was an announcement that Sceptre Investment Counsel was merging its two income trust funds (closed-end) into one and converting it into a mutual fund. There’s nothing wrong with this change (indeed, the unitholders will benefit), but it is an example of the massive amount of restructuring going on in the closed-end fund world.

The restructuring, some of which comes within a year or two of the product’s initial offering, tells me that the products were either improperly structured or were designed strictly to capture a short-term trend. Buyer beware!

The second flag came from reading a monthly update from a Canadian hedge fund manager this week. This manager has a specific strategy aimed at taking advantage of the discount that structured product holders must accept if they want to sell between redemption periods. In simple terms, the hedge fund buys the units at a discount to net asset value (NAV) and then holds the units until the redemption date when they’re entitled to redeem at full NAV. They likely hedge the purchase in some way and importantly, they lever it up to make the return more attractive.

The fact that hedge fund managers are profiting off of the individual investor tells me that many of these structured products are not designed very efficiently. They’re already feeding lots of mouths - investment bankers, securities lawyers, and financial advisors – and now we can add another – the clients of hedge fund managers. Buyer beware!

As I said in a recent Globe and Mail column, closed-end funds are suitable for some types of investments: when there is a high expertise quotient; when leverage is used as part of the investment strategy; when the fund invests in illiquid assets that are inappropriate for an open-end fund; and/or when the fund is amenable to a split share structure. But the concept has been overused. Before investors buy a structured product or a closed-end fund, they should assess whether the structure makes sense for the asset class or investment strategy. In many cases it doesn’t, it’s just a low risk way for the product sponsor to sell the units and build an asset base.

Buyer beware!