What Are Closed-End Funds?
A closed-end fund is a type of mutual fund that issues a fixed number of shares through an initial public offering (IPO) to raise capital for its initial investments. These 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.
Unlike open-end funds, such as most mutual funds and ETFs, closed-end funds do not accept continuous new investment capital. They do not issue new shares nor redeem existing ones on demand.
Closed-end funds are often actively managed, focusing on specific industries, sectors, or regions. They include various categories like municipal bond funds and global investment funds.
Key Insights
- Initial capital for a closed-end fund is raised through a one-time offering of a limited number of shares.
- Shares can be traded on a public stock exchange, but no new shares can be issued.
- Closed-end funds are typically actively managed and often focus on specialized sectors or geographical areas.
Unpacking the Nature of Closed-End Funds
Like other mutual funds, closed-end funds have a manager who actively buys, sells, and holds assets within the portfolio. Their shares can fluctuate in price throughout the trading day, similar to stocks and ETFs. However, apart from specific types like interval funds, closed-end funds do not issue additional shares or repurchase them.
Both closed-end and open-end mutual funds make distributions of income and capital gains to shareholders. They also charge annual expense ratios for their management services and must be registered with the Securities and Exchange Commission (SEC).
Differentiating Closed-End Funds from Open-End Funds
Closed-end funds differ fundamentally from open-end funds. They have a single offering of a fixed number of shares, meaning no new shares are issued after the initial offering is fully sold.
In contrast, open-end mutual funds and ETFs continuously accept new capital, issuing additional shares and buying back shares from investors who want to sell.
Closed-end funds trade on stock exchanges, with prices fluctuating according to supply and demand as well as changes in the value of the fund’s holdings. Meanwhile, open-end mutual funds price their shares only once daily based on the net asset value (NAV) of their portfolios.
Because they trade exclusively in secondary markets, closed-end funds require a brokerage account for transactions, unlike open-end funds, which can often be purchased directly from the investment company.
Pros of Closed-End Funds
- Diversified portfolio
- Professional management
- Transparent pricing
- Potential for higher yields
Cons of Closed-End Funds
- Subject to volatility
- Less liquid than open-end funds
- Available only through brokers
- May trade at significant discounts or premiums
Closed-End Funds and Net Asset Value (NAV)
One of the unique features of closed-end funds is their pricing. While NAV is calculated regularly based on the fund’s assets, the trading price on the exchange is market-driven. Therefore, closed-end funds can trade at a premium or discount to their NAV. Various factors, such as market demand and fund management reputation, can influence this.
Performance Dynamics of Closed-End Funds
Closed-end funds do not repurchase their shares from investors, so they do not need to maintain large cash reserves. This allows them to invest more capital and potentially make use of leverage—borrowed money—to enhance their returns.
As a result, closed-end funds may offer higher overall returns than their open-end counterparts, capitalizing on their market strategies and leverage utilization.
Types of Closed-End Funds
Closed-end funds span across various categories including business development companies (BDCs), real estate funds, commodity funds, and bond funds. The largest by assets under management is the municipal bond funds, known for investing in government and agency obligations.
Managers also create closed-end funds focused on global, international, and emerging markets—oftentimes blending stocks and fixed-income securities.
One of the prominent examples is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG), with total net assets of $2.7 billion as of December 31, 2023.
Unlocking the Potential of Closed-End Funds
Closed-end fund shares trade throughout the day on stock exchanges, offering opportunities to profit from price variations that deviate from NAV.
Comparing to Open-End Funds
Open-end mutual funds continuously issue new shares and redeem existing ones, leveraging new investor capital influx. Closed-end funds, issuing shares only once, add potential volatility through leverage, promising higher rewards and risks.
Evaluating the Risk of Closed-End Funds
A significant downside is the lack of new share issuance, making it necessary to find sellers in order to acquire shares, possibly paying a premium.
The Takeaway
Closed-end funds issue a fixed number of shares, trading actively on stock exchanges, resulting in price fluctuations throughout the trading day. Embracing these funds could mean leveraging market-driven opportunities while understanding their unique risks and rewards.
Related Terms: Open-End Fund, Net Asset Value (NAV), Leverage, Exchange-Traded Funds (ETFs), Market Price.
References
- U.S. Securities and Exchange Commission. “Investment Company Registration and Regulation Package”.
- Eaton Vance. “Tax-Managed Global Diversified Equity Income Fund”.
