Closed-End Funds

In order to discuss closed-end funds, let’s first review open-ended funds, which are traditional mutual funds. Open-ended funds are offered by an investment company and basically have an unlimited supply of shares. Open-ended funds trade at NAV (Net Asset Value). NAV = (Assets – Liabilities) / Total Number of Outstanding Shares. It is the underlying value of the investment divided by how many shares are held by investors. When you buy or sell an open-ended fund, you receive end-of-day pricing.

Closed-end funds have a fixed number of shares offered by an investment company. Because there is a fixed number, they often do not trade at NAV. They trade at a premium or a discount based on supply and demand. Closed-end funds can be traded throughout the day, like ETFs and stocks. Here are some other characteristics:

• Many closed-end funds use active management and are therefore higher in cost than ETFs which are more index-based (passive).
• They can invest in alternative securities, real estate and private placements, which are often less liquid and difficult for investors to access outside of hedge funds and private equity funds that demand significant capital.
• Closed-end funds often use leverage in their investment strategies. Leverage is borrowing money in order to gain greater investment exposure. This magnifies investment returns, leading to greater highs but also lower lows.

So why would people want a more expensive and perceived “riskier” investment? Income. Most closed-end funds focus on providing attractive steady income to their shareholders. You can find funds that invest in US stocks, international stocks, tax-free-bonds, taxable bonds, REITS, and master limited partnerships, but most will have the common theme of higher yield. Closed end funds can often yield 7% or higher.