What Is a Closed-End Fund?

What Is a Closed-End Fund?

Let me explain what a closed-end fund is. It sells a fixed number of shares just once through an initial public offering to gather investment capital. After that, these shares trade on a stock exchange, and no new shares get issued or new money added to the fund.

Compare this to an open-end fund, like most mutual funds and ETFs, which takes in new investment money all the time. It creates new shares and buys back its own shares whenever investors want.

You'll find many municipal bond funds and some global investment funds structured as closed-end funds.

Key Takeaways

Closed-end funds put out a set number of shares in one IPO and trade on exchanges, unlike open-end funds that keep issuing and redeeming shares. These funds might trade above or below their net asset value because of market conditions, which can create chances for you as an investor.

They often borrow money through leverage to amp up returns, leading to bigger potential upsides and downsides than open-end funds. While they can give you higher yields, they're not as liquid as open-end funds and you usually need a broker to get them.

Navigating the Dynamics of Closed-End Funds

Just like many mutual funds, a closed-end fund has a manager who handles the portfolio, actively buying, selling, and holding assets. Shares of closed-end funds, similar to stocks and ETFs, see their prices change during the trading day.

The fund's parent company doesn't issue more shares, and the fund doesn't buy back shares, except for interval funds that can repurchase them. Closed-end funds and open-end mutual funds share similarities: both distribute income and capital gains to shareholders, charge an annual expense ratio, and must register with the SEC.

Comparing Closed-End and Open-End Funds

Closed-end funds stand apart from open-end funds in important ways. They raise a specific amount of capital by selling a fixed number of shares in one offering. Once those shares are sold, the fund closes to new capital.

Most mutual funds and ETFs keep taking in new money from investors, issuing more shares and buying back shares from those who want to sell. A closed-end fund gets listed on a stock exchange, where its shares trade like stocks all day long.

Open-end mutual funds set their share prices once a day at the end of trading, based on the net asset value of the portfolio. For closed-end funds, the stock price moves based on supply and demand plus changes in the fund's holdings.

You trade closed-end funds only on secondary markets, so you need a brokerage account. Open-end funds you can usually buy straight from the company that sponsors them.

How Net Asset Value (NAV) Impacts Closed-End Funds

Pricing sets closed-end funds apart. The fund calculates its NAV regularly from the value of its assets. But the trading price on the exchange comes from market forces, so it can be at a premium or discount to NAV. A premium means the share price is above NAV; a discount means it's below.

This happens for various reasons. The market price might go up if the fund focuses on a hot sector or has a respected manager. Or, poor performance or volatility could scare off investors, pushing the share value down.

Evaluating the Performance of Closed-End Funds

Closed-end funds don't buy back shares from investors, so they don't need big cash reserves, leaving more money for investing. They can also use a lot of leverage—borrowed money—to increase returns. This setup lets them potentially deliver higher returns than open-end mutual funds.

Exploring Examples of Notable Closed-End Funds

There are various types of closed-end funds, including business development companies, real estate funds, commodity funds, and bond funds. The biggest category by assets under management is municipal bond funds. These invest in debt from state and local governments and federal agencies. Managers aim for broad diversification to cut risk but might use leverage for better returns.

Managers also create closed-end funds for global, international, and emerging markets, blending stocks and fixed-income. Global funds mix U.S. and international securities. International funds stick to non-U.S. securities. Emerging markets funds target fast-growing, volatile foreign areas.

One major closed-end fund is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG). Started in 2007, it had $2.7 billion in net assets as of December 31, 2023. Its main goal is current income and gains, with capital appreciation as a secondary aim.

What Are the Advantages of a Closed-End Fund?

Shares trade all day on a stock exchange, and the market price might differ from NAV, giving you chances to profit from premiums or discounts.

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

An open-end fund issues new shares when investors buy in and repurchases them when available. A closed-end fund issues shares only once. Closed-end funds often use leverage to increase returns, meaning higher rewards in good times and higher risks in bad.

What Is the Downside to Closed-End Funds?

A big downside is that no new shares get issued, so to get into one, you have to find a seller willing to part with shares at a premium or wait for some to hit the market.

The Bottom Line

Closed-end funds issue shares only once. When they're all sold, no more are available unless an owner sells. They're generally priced by net asset value, but prices fluctuate during the day since they're actively traded.