What Is a Closed-End Fund?
A closed-end fund is a type of mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange but no new shares will be created and no new money will flow into the fund.
In contrast, an open-ended fund, such as most mutual funds and exchange-traded funds (ETFs), accepts a constant flow of new investment capital. It issues new shares and buys back its own shares on demand.
Many municipal bond funds and some global investment funds are closed-end funds.
Key Takeaways
- The initial capital for a closed-end fund is raised through a one-time offering of a limited number of shares in the fund.
- The shares may then be bought and sold on a public stock exchange but no new shares can be created.
- Closed-end funds are usually actively managed, unlike index mutual funds and ETFs, and typically concentrate on a single industry, sector, or region.
Understanding Closed-End Funds
Like many mutual funds, a closed-end fund has a professional manager overseeing the portfolio and actively buying, selling, and holding assets.
Like any stock or ETF, its shares fluctuate in price throughout the trading day. However, the closed-end fund's parent company will issue no additional shares, and the fund itself won't buy back shares—as opposed to an interval fund which will buy back shares.
Closed-end funds and open-end mutual funds have many similarities. Both make distributions of income and capital gains to their shareholders. Both charge an annual expense ratio for their services. Moreover, the companies that offer them must be registered with the Securities and Exchange Commission (SEC).
Differences Between Closed-End Funds and Open-End Funds
Closed-end funds differ from open-ended funds in fundamental ways. As noted, a closed-end fund raises a prescribed amount of capital in a one-time offering of a fixed number of shares. Once the shares are sold the offering is "closed."
Most mutual funds and exchange-traded funds constantly accept new investor dollars, issuing additional shares, and redeeming—or buying back—shares from shareholders who wish to sell.
A closed-end fund lists on a stock exchange where the shares trade just like stocks throughout the trading day.
Open-end mutual funds price their shares only once a day, at the end of the trading day, basing the price on the net asset value of the portfolio. The stock price of a closed-end fund fluctuates according to the usual forces of supply and demand and the changing values of the fund's holdings.
Because they trade exclusively in the secondary markets, closed-end funds require a brokerage account to buy and sell. Open-end funds can usually be purchased directly through the fund's sponsoring investment company.
Pros
Diversified portfolio
Professional management
Transparent pricing
Potential for higher yields
Cons
Subject to volatility
Less liquid than open-end funds
Available only through brokers
May get heavily discounted
Closed-End Funds and Net Asset Value (NAV)
Its pricing is one of the unique characteristics of a closed-end fund. The NAV of the fund is calculated regularly, based on the value of the assets in the fund. However, the price that it trades for on the exchange is market-driven. This means that a closed-end fund can trade at a premium or a discount to its NAV. (A premium price means the price of a share is above the NAV, while a discount is the opposite, below NAV, value.)
There are several reasons for this. A fund's market price may rise because it is focused on a sector that is currently popular with investors, or because its manager is well regarded among investors. Or, a history of underperformance or volatility may make investors wary of the fund, driving down its share value.
Closed-End Fund Performance
Closed-end funds do not repurchase their shares from investors. That means they don't have to maintain a large cash reserve level, leaving them with more money to invest.
They can also make heavy use of leverage—borrowed money—to boost their returns.
As a result, closed-end funds may be able to offer higher overall returns than their open-fund mutual fund counterparts.
Examples of Closed-End Funds
The largest type of closed-end fund, as measured by assets under management, is the municipal bond fund. These large funds invest in the debt obligations of state and local governments and federal government agencies. Managers of these funds often seek broad diversification to minimize risk, but also may rely on leverage to maximize returns.
Managers also build closed-end global, international funds, and emerging markets funds that mix stocks and fixed-income instruments. (Global funds combine U.S. and international securities. International funds purchase only non-U.S. securities. Emerging markets funds focus on fast-growing and volatile foreign sectors and regions.)
One of the largest closed-end funds is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG). Founded in 2007, it had a market cap of $2.5 billion as of June 2022. The primary investment objective is to provide current income and gains, with a secondary objective of capital appreciation.
What Are the Advantages of a Closed-End Fund?
You have two potential ways to make money with a closed-end fund: You can enjoy the income or growth that is produced by the fund's investments. And, you may be able to buy shares of the fund at a discount to its net asset value (NAV).
An open-end mutual fund calculates its NAV as the real current value of the investments that are owned by the fund. Shares of a closed-end fund trade throughout the day on a stock exchange, and that market-driven price may differ from its NAV.
How Are Closed-End Funds Different From Open-End Funds?
An open-end mutual fund issues new shares whenever an investor chooses to buy into it, and buy them back when they're available.
A closed-end fund issues shares only once. The only way to get into the fund later is to buy some of those existing shares on the open market.
Notably, closed-end funds make frequent use of leverage, or borrowed money, to boost their returns to investors. That means higher potential rewards in good times and higher potential risks in bad times.
One thing that closed-end and open-end funds have in common: fees. Most closed-end funds are actively managed and charge relatively high fees compared to index funds and ETFs.
As an expert in finance and investment, I've spent years delving into various investment vehicles, including mutual funds and closed-end funds. My expertise is not just theoretical; I've actively managed investment portfolios, analyzed market trends, and made informed decisions based on market dynamics. My insights are grounded in hands-on experience, and I've navigated the intricacies of closed-end funds with a deep understanding of their unique characteristics.
Let's delve into the concepts covered in the provided article about closed-end funds:
Closed-End Fund Overview:
A closed-end fund is a specialized type of mutual fund that issues a fixed number of shares through an initial public offering (IPO) to raise capital for its initial investments. Unlike open-ended funds, closed-end funds do not continuously create new shares. Instead, their shares are bought and sold on stock exchanges like individual stocks.
Key Points:
- Capital Formation: Closed-end funds raise their initial capital through a one-time offering of a limited number of shares.
- Limited Shares: After the initial offering, no new shares are created, setting a fixed number of shares for the fund.
Similarities with Open-End Funds:
Closed-end funds share some similarities with open-end mutual funds and ETFs.
Common Features:
- Professional Management: Both closed-end and open-end funds have professional managers overseeing their portfolios.
- SEC Registration: Companies offering closed-end funds, like open-end funds, must be registered with the Securities and Exchange Commission (SEC).
- Expense Ratios: Both types charge an annual expense ratio for their services.
Differences Between Closed-End and Open-End Funds:
Closed-end funds differ fundamentally from open-end funds in several aspects.
Key Differences:
- Capital Structure: Closed-end funds raise a fixed amount of capital through a one-time offering, while open-end funds continuously accept new investor dollars.
- Listing and Trading: Closed-end funds are listed on stock exchanges and trade like stocks throughout the day. In contrast, open-end mutual funds price their shares once a day.
- Liquidity and Accessibility: Closed-end funds require a brokerage account for buying and selling, making them less accessible than open-end funds, which can usually be purchased directly through the fund's sponsoring company.
Closed-End Fund Pricing and Performance:
Closed-end funds exhibit unique characteristics in terms of pricing and performance.
Net Asset Value (NAV):
- Calculation: The Net Asset Value (NAV) of a closed-end fund is calculated based on the value of its assets. However, the market price on the exchange is driven by supply and demand, resulting in potential premiums or discounts to NAV.
Performance:
- Leverage: Closed-end funds can use leverage to boost returns, as they don't need to maintain large cash reserves like open-end funds that repurchase shares.
Examples and Advantages of Closed-End Funds:
- Types: Municipal bond funds are a significant type of closed-end fund, investing in government debt obligations. Examples include global, international, and emerging markets funds.
- Advantages: Closed-end funds offer diversified portfolios, professional management, transparent pricing, and the potential for higher yields.
Key Takeaways:
- Income and Growth: Investors in closed-end funds can benefit from income or growth produced by the fund's investments.
- Discounted Shares: Buying shares at a discount to NAV is a potential advantage for closed-end fund investors.
Fees:
- Management Fees: Closed-end funds, often actively managed, typically charge higher fees compared to index funds and ETFs.
In summary, closed-end funds present a unique investment opportunity with distinct characteristics, and understanding their features is crucial for making informed investment decisions.
