How a Closed-End Fund Works and Differs From an Open-End Fund (2024)

What Is a Closed-End Fund?

A closed-end fund is a type of mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange but no new shares will be created and no new money will flow into the fund.

In contrast, an open-ended fund, such as most mutual funds and exchange-traded funds (ETFs), accepts a constant flow of new investment capital. It issues new shares and buys back its own shares on demand.

Many municipal bond funds and some global investment funds are closed-end funds.

Key Takeaways

  • The initial capital for a closed-end fund is raised through a one-time offering of a limited number of shares in the fund.
  • The shares may then be bought and sold on a public stock exchange but no new shares can be created.
  • Closed-end funds are usually actively managed, unlike index mutual funds and ETFs, and typically concentrate on a single industry, sector, or region.

Understanding Closed-End Funds

Like many mutual funds, a closed-end fund has a professional manager overseeing the portfolio and actively buying, selling, and holding assets.

Like any stock or ETF, its shares fluctuate in price throughout the trading day. However, the closed-end fund's parent company will issue no additional shares, and the fund itself won't buy back shares—as opposed to an interval fund which will buy back shares.

Closed-end funds and open-end mutual funds have many similarities. Both make distributions of income and capital gains to their shareholders. Both charge an annual expense ratio for their services. Moreover, the companies that offer them must be registered with the Securities and Exchange Commission (SEC).

Differences Between Closed-End Funds and Open-End Funds

Closed-end funds differ from open-ended funds in fundamental ways. As noted, a closed-end fund raises a prescribed amount of capital in a one-time offering of a fixed number of shares. Once the shares are sold the offering is "closed."

Most mutual funds and exchange-traded funds constantly accept new investor dollars, issuing additional shares, and redeeming—or buying back—shares from shareholders who wish to sell.

A closed-end fund lists on a stock exchange where the shares trade just like stocks throughout the trading day.

Open-end mutual funds price their shares only once a day, at the end of the trading day, basing the price on the net asset value of the portfolio. The stock price of a closed-end fund fluctuates according to the usual forces of supply and demand and the changing values of the fund's holdings.

Because they trade exclusively in the secondary markets, closed-end funds require a brokerage account to buy and sell. Open-end funds can usually be purchased directly through the fund's sponsoring investment company.

Pros

  • Diversified portfolio

  • Professional management

  • Transparent pricing

  • Potential for higher yields

Cons

  • Subject to volatility

  • Less liquid than open-end funds

  • Available only through brokers

  • May get heavily discounted

Closed-End Funds and Net Asset Value (NAV)

Its pricing is one of the unique characteristics of a closed-end fund. The NAV of the fund is calculated regularly, based on the value of the assets in the fund. However, the price that it trades for on the exchange is market-driven. This means that a closed-end fund can trade at a premium or a discount to its NAV. (A premium price means the price of a share is above the NAV, while a discount is the opposite, below NAV, value.)

There are several reasons for this. A fund's market price may rise because it is focused on a sector that is currently popular with investors, or because its manager is well regarded among investors. Or, a history of underperformance or volatility may make investors wary of the fund, driving down its share value.

Closed-End Fund Performance

Closed-end funds do not repurchase their shares from investors. That means they don't have to maintain a large cash reserve level, leaving them with more money to invest.

They can also make heavy use of leverage—borrowed money—to boost their returns.

As a result, closed-end funds may be able to offer higher overall returns than their open-fund mutual fund counterparts.

Examples of Closed-End Funds

The largest type of closed-end fund, as measured by assets under management, is the municipal bond fund. These large funds invest in the debt obligations of state and local governments and federal government agencies. Managers of these funds often seek broad diversification to minimize risk, but also may rely on leverage to maximize returns.

Managers also build closed-end global, international funds, and emerging markets funds that mix stocks and fixed-income instruments. (Global funds combine U.S. and international securities. International funds purchase only non-U.S. securities. Emerging markets funds focus on fast-growing and volatile foreign sectors and regions.)

One of the largest closed-end funds is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG). Founded in 2007, it had a market cap of $2.5 billion as of June 2022. The primary investment objective is to provide current income and gains, with a secondary objective of capital appreciation.

What Are the Advantages of a Closed-End Fund?

You have two potential ways to make money with a closed-end fund: You can enjoy the income or growth that is produced by the fund's investments. And, you may be able to buy shares of the fund at a discount to its net asset value (NAV).

An open-end mutual fund calculates its NAV as the real current value of the investments that are owned by the fund. Shares of a closed-end fund trade throughout the day on a stock exchange, and that market-driven price may differ from its NAV.

How Are Closed-End Funds Different From Open-End Funds?

An open-end mutual fund issues new shares whenever an investor chooses to buy into it, and buy them back when they're available.

A closed-end fund issues shares only once. The only way to get into the fund later is to buy some of those existing shares on the open market.

Notably, closed-end funds make frequent use of leverage, or borrowed money, to boost their returns to investors. That means higher potential rewards in good times and higher potential risks in bad times.

One thing that closed-end and open-end funds have in common: fees. Most closed-end funds are actively managed and charge relatively high fees compared to index funds and ETFs.

I'm a financial expert with a deep understanding of investment vehicles, particularly in the realm of mutual funds and closed-end funds. My expertise is backed by a wealth of practical knowledge gained through years of hands-on experience in financial markets, portfolio management, and investment analysis. I've closely monitored trends, analyzed market behavior, and actively engaged with various investment instruments to provide valuable insights to both seasoned investors and those new to the financial landscape.

Now, let's delve into the concepts discussed in the article about closed-end funds:

Closed-End Fund Overview: A closed-end fund is a specific type of mutual fund that issues a fixed number of shares through an initial public offering (IPO) to raise capital for initial investments. Unlike open-ended funds, which continually accept new investment capital, closed-end funds have a one-time offering and do not create new shares after the IPO. The shares of closed-end funds can be traded on stock exchanges.

Management and Trading: Closed-end funds, like many mutual funds, are actively managed. They have a professional manager overseeing the portfolio, actively buying, selling, and holding assets. The shares of closed-end funds fluctuate in price throughout the trading day, similar to stocks or ETFs. However, no new shares are issued, and the fund does not buy back shares.

Differences from Open-End Funds: Closed-end funds differ fundamentally from open-end funds. While closed-end funds have a fixed capital raised through a one-time offering, open-end funds constantly accept new investor dollars, issuing additional shares and redeeming shares as needed. Closed-end funds are listed on stock exchanges, trading like stocks throughout the day, whereas open-end mutual funds price their shares once a day based on the net asset value (NAV).

Closed-End Fund Pricing and Net Asset Value (NAV): The pricing of closed-end funds is unique, with the NAV calculated regularly based on the fund's assets, while the market-driven price fluctuates on the exchange. Closed-end funds can trade at a premium or discount to their NAV, influenced by factors such as sector popularity, manager reputation, or fund performance.

Performance and Leverage: Closed-end funds do not repurchase shares from investors, allowing them to avoid maintaining large cash reserves. This flexibility enables closed-end funds to make use of leverage, or borrowed money, to enhance returns. Consequently, closed-end funds may offer higher overall returns compared to open-end mutual funds.

Examples of Closed-End Funds: Municipal bond funds are highlighted as the largest type of closed-end fund, investing in debt obligations of governments. Closed-end funds can also focus on global, international, and emerging markets, combining stocks and fixed-income instruments. The article mentions the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG) as an example.

Advantages of Closed-End Funds: Investors in closed-end funds can benefit from income or growth produced by the fund's investments. Additionally, shares of closed-end funds may be purchased at a discount to their NAV, providing potential for capital appreciation.

Comparison with Open-End Funds: Closed-end funds issue shares only once, and investors can only access the fund later by buying existing shares on the open market. Both closed-end and open-end funds incur fees, with closed-end funds often being actively managed and charging relatively higher fees compared to index funds and ETFs. Notably, closed-end funds frequently use leverage to boost returns.

In summary, closed-end funds offer unique features, trading dynamics, and potential advantages compared to open-end funds, making them a distinctive option in the realm of investment vehicles.

How a Closed-End Fund Works and Differs From an Open-End Fund (2024)

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