» Learn the Basics of Mutual Funds » Closed-end Fund Definition

Closed-end Fund Definition

Definition: To better grab the essence of closed-end funds think of them as a company that buys, manages and sell stocks and bonds of other companies and at the same time has its own stocks that are market tradable at their NAV (Net Asset Value).

The basic similarity between closed-end funds and mutual funds (also called open-end funds) is that they both accumulate investors' money in order to use them for the purchase of stocks and bonds. Another similarity is the fact that they are both managed by a fund manager.

Open-end funds vs. Closed-end funds

As their name implies, open-end funds are open to new investors who are willing and able to put their money in the fund. The fund continues to be an open-end one even if the managers decide to close it for outsiders. Under such conditions, the participating investors are allowed to purchase new shares and the need for finding a buyer when they decide to sell is cut.

On the other hand, the number of the shares that a closed-end fund has is fixed. They have initial public offering in the same way as a newly set publicly traded company. In this type of fund every seller should be matched with a corresponding buyer and the fund's shares are traded in accordance with the market demand and supply laws.

Closed-end Fund Advantages

  1. Can be traded at below their NAV, meaning that they can be purchased at a discount.
  2. Can be traded at above their NAV, meaning that they can be sold at a premium.
  3. They can implement some investments and techniques that are not widely used in mutual funds.

Closed-end Fund Disadvantages

  1. The premium and discount trade pros can be turned into cons due to the possibility of misuse.
  2. Too much broker fees and commissions.
  3. Riskier than mutual funds.
  4. Harder to sell, which implies problems with liquidity. Additionally, the company is not obliged to purchase the shares back, which deprives them of redeemability.
  5. Management fees
  6. Scarcity of information about the prices of closed-end funds.
  7. Less attractive to adept managers.

A piece of advice: Even though closed-end funds are more efficient when it comes to coping with price inefficiencies, it is highly advisable to hold up to the mutual funds, since this advantage cannot compensate for the high fees and scarcity of liquidity.  

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