Powershares filed to create a closed-end fund way back in April that might raise some eyebrows. The fund will invest in publicly traded stocks and other investment vehicles of companies or institutions that invest in or lend capital to privately held companies. The fund manager will follow closely--but not necessarily track--a model portfolio determined by Red Rocks Capital Partners. At first glance, the Powershares ACCE Global Listed Private Equity Fund seems to be pretty normal.

But move on down in the filing to the second paragraph of the stated "Investment Objective" and you'll see that this fund has a twist: After 180 days of trading, should the fund trade at a median 3% discount to net asset value (NAV) for 30 consecutive trading days, it will convert to an open-end exchange-traded fund (ETF) automatically, with no shareholder approval necessary. The ETF would then track an index based on the Red Rocks Capital model portfolio.

One of the great mysteries of the CEF industry is why the funds so often trade at a discount to NAV. CEF providers have been trying to figure out for years how to keep their funds from trading at a discount, and it appears Powershares is hoping this might be a solution. The "threat" of conversion may incentivize investors to keep the discount at a minimum.

However, a less benevolent reason may be a motivation as well. CEF initial public offerings have extra sales charges or loads attached to them in addition to the usual brokerage commission. Fund companies and brokers love these loads, because it pays them to actively sell the fund. One of the big sticking points in the ETF industry has been that it is difficult to pay brokers for selling the funds. Large actively managed fund houses rely on commissioned broker sales to drive assets; those 2%, 3% and 5.25% loads ensure that brokers push their product. Compensating brokers for ETF sales is much more complicated; no one's figured out how to attach a load effectively to an ETF.

[Back in 2004, in a filing to launch 25 ETFs, Powershares had wanted to make the ETFs available to investors through the authorized participants, who could then add a sales charge of up to 2%. This mechanism, similar to a mutual fund load, was intended to incentivize brokers to sell the products to investors. However, the charge was never applied, and no one has really figured out exactly how it would work.]

What's so clever - or devious - about the new PowerShares filing is that, once the IPO is out of the way, the fund can quickly convert to an ETF, which would both benefit shareholders and allow PowerShares to attract new assets to the fund. (Traditional CEFs cannot grow assets under management, as they are fixed at the level of the IPO; ETFs can.)

With a discount threshold set at 3%, a conversion on the proposed fund is a definite possibility: Discounts well into the teens are not unusual for CEFs, and the average for the week ended August 10 was 6.28%, according to a Thomson Financial figure quoted on the Site-by-Site! Web site.

There is a limited history of CEF to ETF conversions. First Trust Advisors went into uncharted territory earlier this year when it converted two of its closed-end funds to ETFs, primarily because of the discounts at which they were trading. Those conversions, however, were not dictated by the prospectus, and were subject to prior approval. Both of the First Trust funds also have seen declines in assets since converting, with the First Trust Value Line Dividend Index Fund (AMEX: FVD) notably now at less than 50% of its asset level at the time of the conversion.

Many people thought that the First Trust conversions would set off a wave of similar activities, but so far, that hasn't happened ... in part because of the falling assets. The "threat" of conversion has narrowed the discounts for index-like CEFs across the board, but it has not caused them to disappear by any means.

The Powershares filing is different because it is the first to lay out the parameters for a conversion ahead of time. It aims to achieve the best of both possible worlds for the fund issuer: a CEF sales load with the performance and possible asset growth of an ETF.

It will be interesting to see how investors react to the fund should it launch. Will it be traded by investors counting on the ETF conversion to bring them added alpha? Will the 3% threshold serve to attract only serious private equity investors who will maintain a trading price close to NAV? Or will the IPO fizzle because investors feel they are being manipulated - after all, the folks who buy the fund at the IPO and could just as easily buy the fund one day later without the extra fees? But then again, that's always been the case with CEFs, so you have to wonder: will the CEF investors even notice?