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? Closed-end funds are chosen because they 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 closed-end fund manager doesn't have to worry about a significant 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.
