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A Primer on Closed-end Funds

Mutual funds come in different flavors; they could vary in their investment styles (growth, value, or blend of both), type of securities held (stocks or bonds), sectors (energy, utilities, financial to name but a few), etc. They also differ in their mode of operation: namely, open-end or closed-end funds.

Open-end Funds

Many investors would be aware of the open-end structure of mutual funds: they are traded directly by the fund company to unit holders and there is no restriction on the number of units that can be created by the company. The unit price is determined using the net asset value of the fund and calculated at the end of every trading day by the mutual fund company, thereby ensuring that every trader on a particular day pays the same price.

Open-end funds offer instant liquidity as they can be redeemed on any trading day. However, buy or sell order executions for a large number of units in quick time affects the fund’s portfolio value due to the manager’s need to generate cash.

Closed-end Funds

On the other hand, closed-end funds are issued in limited (fixed) units by a fund company to invest according to the fund’s investment objectives. They trade on an exchange like stocks and ETFs and the trading price is dictated by supply and demand unlike open-end funds. There is no official minimum amount for a trade but, as may be evident, a trader of closed-end funds would pay trading commissions to cover the cost of the trade. Hence, a trader would be better off to set a personal minimum amount to keep brokerage expenses at an economical level. For tax purposes, distributions made by closed-end funds are considered to be similar to those paid out by open-end funds.

Generally, closed-end funds have poor liquidity and the bid-ask spread is a key factor to be considered when trading them. Due to their availability for trade on an exchange, they provide opportunities for buying at a discount, since the market price may drop below the net asset value. Nonetheless, it should be noted that premium price situations are also likely to occur. Closed-end funds are usually actively managed by investment advisers and may not offer the passive, index-tracking type of investing sought by many ETF investors. They also employ leverage to boost returns that introduces a risk factor, not involved in open-end funds, into the mix.

Popularity of Closed-end Funds

Many investors may recognize that closed-end funds do not receive as much attention as their counterparts. Reasons include low liquidity, complicated structure involved, premium/discount factors, and lack of research coverage by investment firms. The Wealthy Boomer website featured a good article about this subject some time back.

Resources for Closed-end Funds

This Closed-End Fund Association (CEFA) page offers good insight into a closed-end fund’s attributes by offering details such as return %, premium/discount statistics, expense ratio, leverage assets %, etc. The website has a vast array of information for closed-end fund investors. The Globe Fund database also provides good information for interested readers.

Do you hold closed-fund funds? Why did you choose closed-end funds instead of (or in addition to) the more famous open-end funds? How have your returns been?

About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism.  You can read his other articles here.

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About the author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.

{ 3 comments… add one }
  • Jeff October 12, 2011, 11:50 am

    The Wealthy Boomer link seems to be broken.

  • Clark October 12, 2011, 8:56 pm

    Jeff, thanks for pointing it out. The link is correct but it is their website that is causing the problem. You can see a preview of the article at the link below but the “Click here to read more” link on the page leads to the broken link I gave in the post.

    http://network.nationalpost.com/NP/blogs/wealthyboomer/archive/tags/closed-end+funds/default.aspx

  • Engineering Income October 13, 2011, 7:38 pm

    Something interesting about closed-end funds to consider (vs. a comparable open ended fund) is that during times of market distress, CEF’s may perform better than their counterparts because they are not forced to sell stocks (or whatever) to meet redemption requests as the number of units is fixed. As CEF’s trade on the market, they also can’t stop redemption requests either so if you absolutely have to get your money out, you’re more likely to be able to sell in a hurry. These scenarios don’t pop up often, but when they do, it can be an important difference.

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