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Investing In Closed-End Funds
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History
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Generally speaking, when investors talk about mutual funds they are talking
about open-end mutual funds. However, there is another type of fund called a
closed-end fund. Both types of funds have professional managers who pool
shareholders money to purchase securities in keeping with an investment
strategy. And they both value the securities in the fund at the end of every
business day to arrive at the fund’s net asset value. The main difference
between the two types of funds is in how they trade.
Open and Closed
An open-end fund sells shares directly to investors and stands ready to buy
them back any time at net asset value minus any sales charge. Shares of a
closed-end fund trade on a public exchange. As a result, a closed-end fund’s
share price fluctuates based on what another investor is willing to pay rather
than on the market value of the securities in the fund. A closed-end fund’s
shares may trade above their net asset value, which is called a premium, or
below their net asset value, which is called a discount. The price an investor
pays to purchase shares in a closed-end fund only partially reflects the value of
the securities in the fund. It also reflects supply and demand and the market’s
outlook on the fund.
Control is the key
Why do some funds choose a closed-end structure? Because closed-end funds
are ideal for certain types of markets—for example, foreign markets that are
small and illiquid—and for investment strategies that employ leverage or other
special management techniques that require a steady pool of assets. A closedend
fund manager doesn’t have to worry about a big outflow or inflow of
money, because a closed-end fund has a fixed number of shares and the fund
company is not responsible for redeeming them. As a result, the manager has
more control in managing the fund.
Closed-end funds are a little more complicated than open-end funds. But if a
closed-end fund opens the door to a market or a strategy that would be hard to
get at in another way, it may be worth considering for the diversification
potential it offers.
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