The discount on closed-end
funds is widely accepted as proof of investor irrationality. We show, to the
contrary, that a very simple parsimonious rational model can generate a
discount that exhibits the behavior observed in practice. The only required
features of the model are that managers have (imperfectly observable) ability
to generate excess returns; they sign long-term contracts guaranteeing them a
fee each year equal to a fixed fraction of assets under management; and they
can leave to earn more money elsewhere if they turn out to be good. With these
assumptions, time-varying discounts are not an anomaly in a rational world with
competitive investors --- they are required.