If you’re not a financial professional, you might be overwhelmed with the assortment of investments available in your retirement portfolio. You don’t know where to start!
Luckily for you, we’ve created this article about closed-end funds that will put all of those worries at ease. We cover everything from what closed-end funds are, how they work, the risks and rewards associated with them, and the best places to invest your money.
What is a Closed-End Fund?
A closed-end fund (CEF) is a publicly-traded mutual fund that has a finite number of shares outstanding. Unlike open-ended or public mutual funds, CEFs don’t continuously issue and redeem their shares in the course of investor trading and investment. They also are not actively managed by portfolio managers aiming to outperform the market as a whole. The main function of CEFs is to provide investors with exposure to a specific type of investment, generally real estate or stocks. For example, you could invest your money into a CEF that focuses on Brazilian stocks, thus diversifying your portfolio.
How Do Closed-End Funds Work?
CEFs must sell new shares to investors in order to raise capital, and they sell them at a set price. The number of shares that are available is determined by the fund on a per-share basis. After they have sold the requisite amount of shares, CEFs trade like stocks and their prices fluctuate according to market conditions the same way stocks do. In the example above, you would purchase your Brazilian stock CEF at the set price based on the number of shares that were available at that time. The value of your investment can increase or decrease depending on market forces.
CEFs are governed by the rules set forth by the SEC and must issue annual reports to their shareholders. They also must abide by the Investment Company Act of 1940.
The Basics of Closed-End Funds
Closed-End Mutual Funds are also known as fixed-net investment companies or fixed net asset value (NAV) companies. They differ from Exchange Traded Funds (ETFs) in that they only sell a limited number of shares to investors. Once this supply is sold out, there is no way for investors to purchase the stock unless another investor decides to sell their shares.
Closed-End Funds were originally introduced in 1996 by a number of companies called "Asset-Backed Securities" (ABS) firms. The first steps to the development of Closed-End Funds were taken in the 1960s, but it was not until the late 1980's that the ABS market began to take hold.
In 1999, after many years of research and development, BlackRock Inc. launched its first closed-end fund – BlackRock Global Allocation Fund (NYSE: GXG ) and after more than a year of positive performance, additional closed-end funds have been established.
The Advantages of Closed-End Funds
As opposed to Exchange Traded Funds (ETFs), closed-end funds do not have a stock exchange where their shares are traded. As a result, these shares enjoy a number of advantages over other types of investments such as ETFs.
One of the main advantages is that closed-end funds are more liquid than ETFs. This means that you can buy and sell them easily in the open market, immediately after trading hours. It also means that, unlike ETFs which only trade based on the closing price for the day, closed-end funds always trade at NAV prices, making them more liquid than certain ETFs and other types of investments such as stocks. This can be very advantageous in times of high uncertainty when ETFs may close down and have limited trading hours.
The advantages of Closed-End Funds over ETFs can be summarized as follows:
Closed-End Funds are more liquid than ETFs. They trade at their NAV price and experience fewer trading limitations.
Closed-End Funds offer a higher degree of transparency about the value of your investment, whereas certain types of mutual funds must use estimated values instead of the actual NAV.
Closed-End Mutual Funds also provide dividends to investors that are paid every three months or half-year, unlike ETFs that only pay dividends twice per year.
The disadvantages of Closed-End Funds
As with anything else in life, there are some disadvantages to Closed-End Funds. These disadvantages only apply to specific funds, so investors must carefully check the risk profile of each individual Closed-end Fund before deciding whether or not to invest.
There is no need for you to purchase any additional shares beyond your initial investment if you invest in a closed-end fund. Also, unlike open-end funds where you can purchase additional shares at any time if you decide that it is the right time to make a change and sell your shares it will be very hard to do so or you will receive negative consequences. Therefore, closed-end funds are considered an "investment" rather than an "income-generating tool".
Where Closed-End Funds differ from other Mutual Funds
When investing in a closed-end fund, you are essentially receiving shares in a company and paying for them with money. The reason that the shares are called "closed" is that once you make your initial investment, it cannot be changed (read our article on "How to Identify the Right Mutual Funds").
Unlike Exchange Traded Funds, the NAV of Closed-End funds is always the same price and cannot fluctuate with the share price. The NAV however can change if there are large withdrawals from investors to cover operating expenses.
Conclusion
In closing, we want to make it clear that closed-end funds are an excellent investment option for investors who seek both the stability of an investment and their return in the form of dividends.
We also hope that this article has helped you to grasp the basic differences between closed-end funds and other types of investments such as ETFs. Remember, it pays to do your research before making a decision about which investments best suit your needs.
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