Thursday 29th June 2017,

Business & Marketing

Ξ Leave a comment

What is a Closed-End Fund? Why do People Invest in Them?

posted by Donnamira Whitfoot
What is a Closed-End Fund? Why do People Invest in Them?

From time to time, open-end funds do close, but closed-end funds rarely become open-end funds. Many features of open- and closed-end funds are similar. Their portfolios may include a variety of securities, or they may focus on a specific sector or market area, like global equities or municipal bonds. Both are professionally managed with a clearly stated investment objective. Any dividends or capital gains the funds realize pass through to shareholders.

Open-End Funds are Open at Both Ends, on Demand

Because open-end funds issue new shares and buy them back (redeem them) on demand, the number of shares outstanding constantly changes. If an open-end fund grows to a size that the managers believe is too large to manage effectively, they may close the fund to new investors. Existing shareholders are usually allowed to buy additional shares and reinvest distributions, but the fund does not accept “new money.” When existing shareholders redeem their shares, the old shares are eliminated and the fund gradually shrinks in size.

Closed-End Funds Have a Fixed Number of Shares

The value of closed-end fund shares rises and falls with the securities in the portfolio, but the manager generally does not issue or redeem shares. The sponsoring company begins with an initial public offering (IPO), much like a private company does when it goes public. Once the IPO is over, money is pooled and invested, and shares of the newly created closed-end fund trade over-the-counter.

Investors can buy or sell shares of closed-end funds any time the market is open, but these transactions do not impact the fund’s day-to-day operations. Unlike managers of open-end funds, closed-end fund managers don’t have to keep cash on hand to honor redemptions. And if demand for shares mounts, they don’t have to scramble to put the influx of cash to work. In general, closed-end funds may be less of a headache to manage.

Net Asset Value is the Basis of All Funds

Both open- and closed-end funds calculate the net asset value (NAV) of their shares by adding up the value of the assets in the fund, subtracting the fund’s expenses, and dividing by the number of shares outstanding. Open-end funds must calculate the NAV of their shares by 4 p.m. each trading day. Closed-end funds also calculate NAVs, but this is not a daily necessity because the selling price of closed-end shares is their bid price at any time the market is open.

Basic differences between closed- and open-end shares are:

Buying Shares:

  • Closed-end shares are listed and sold on major exchanges like a stock or bond. Standard brokerage fees apply.
  • Open-end funds may be purchased from a broker/dealer or directly from the fund. Investors’ purchase price may be adjusted for sales or redemption charges.

Note: Most open-end funds sold through dealers are offered with a “load,” or sales charge, that must be paid when shares are purchased or when they are sold, or both. “No-load” funds are sold directly to the public by the investment company, usually with no sales charge. All funds deduct expenses before distributions are paid to shareholders.

Selling Shares

  • Closed-end shareholders who want to cash out must find people who want to buy them.
  • Open-end funds are obliged to buy their shares back at the NAV whenever shareholders want to cash out.

Trading Shares

  • Closed-end shares trade any time the market is open. Shareholders can use such strategies as limit or stop orders.
  • Open-end fund shares only trade after the close of business each day.

Share Valuations

  • Closed-end fund shares are valued by the marketplace. If demand for shares is high, their prices will be high, and vice versa.
  • Open-end shares are valued based on their NAV at the close of business.

Closed-End Funds and ETFs

Closed-end funds are often described as a type of exchange-traded fund (ETF). However, most ETFs are passive investments designed to track an index, whereas most closed-end funds are actively managed. Although the value of closed-end fund shares reflect market trends, they can rise or fall independently of the fund’s NAV.

Since the supply of closed-end shares is limited, strong demand may cause them to sell at a premium to their net asset value. Weak demand causes them to sell at a discount. The prospect of an attractive discount is one of the reasons closed-end funds are popular. Discounts can be as large as 30% to 70% or more. The Closed End Fund Association hosts a website with daily and historical performance information and offers a free, downloadable brochure.

Leave a Reply

Get Social

Like us

Home Care

Health

shared on wplocker.com