What are Closed-End Mutual Funds?
Many passive investors love the convenience of mutual funds. Not only do these funds parlay investor dollars into greater returns for members, they’re also managed by an investment expert. For people who want a “set it and forget it” investment, there are few better options. The only question you’ll need to ask is whether an open or closed-end mutual fund is the right approach.
If you’re looking for a mutual fund with transparent pricing and the potential for higher yields, a closed-end mutual fund might be the best approach. While these funds tend to be less liquid than their open-ended counterparts, they provide some key benefits that make them appealing to investors who want the security of a managed investment product.
Here’s a closer look at closed-end mutual funds: how they work, how they differ from open-ended funds and the pros and cons associated with them.
How a Closed-End Mutual Fund Works
The structure of a closed-end mutual fund is similar to a public company in that it offers a finite number of shares to investors. The mutual fund needs to go through a process similar to an IPO, which raises money and allows the fund to buy shares to develop its portfolio. At IPO, there are a limited number of authorized shares that become available. The fund doesn’t create any new shares or buy back any outstanding shares.
Closed-end mutual fund shares trade on the open market like stocks or ETFs. And, like these products, the price per share rises and falls throughout the trading period.
At the helm of a closed-end mutual fund is a fund manager, charged with buying and selling assets in accordance with the fund’s established strategy. Their actions are what influence the performance of the fund and the returns shareholders can expect via price appreciation and distributions.
Closed vs. Open Mutual Funds
Opposite closed-end mutual funds are open-ended funds. In many ways, the two are very similar. They both distribute capital gains and dividends to shareholders, and they both charge an expense ratio. Key differences become apparent when talking about fund share structure and share price.
Where closed-end funds have a finite number of shares, open-ended funds continually issue new shares and buy back shares from investors. This is where the names come into play. Closed funds aren’t open to investment when there aren’t any available shares; open funds are always open to investors. As a result, open-ended funds are more liquid than closed-end funds.
The other chief difference between the two is that, while closed-end mutual funds see price movement throughout a trading period, open-ended funds don’t. Instead, an open-ended fund is priced at the end of the trading period, based on the net asset value (NAV) of the portfolio. While a closed-end fund also has a NAV, the price per share can trade at a premium or discount relative to the NAV based on market forces.
Examples of Closed-End Mutual Funds
There are a wide variety of closed-end funds out there, each with its own thesis and investing style. For instance, conservative investors may choose a municipal bond fund for its stability, while more aggressive investors seek out international funds for their potential. Some examples of different closed-end mutual funds include:
- Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG) (Balanced)
- Voya Emerging Markets High Dividend Equity Fund (IHD) (International)
- ASA Gold and Precious Metals Limited (ASA) (Commodities)
- BlackRock Taxable Municipal Bond Trust (BBN) (Income)
- Nuveen Real Estate Income Fund (JRS) (REIT)
- Ecofin Sustainable and Social Impact Fund (TEAF) (ESG)
Most fund managers structure closed-end mutual funds with a level of balance to ensure stability. It’s important to look at the fund’s prospectus and the track record of its manager before opening a position.
The Pros of a Closed-End Fund
The positives of a closed-end fund center around the structure of its shares: specifically, the limited number available. Because the fund doesn’t need to create new shares or buy back outstanding shares, it needs less liquid cash on-hand. This, in turn, allows it to invest more and generate stronger returns for shareholders.
Closed-end funds also benefit from better transparency, since the price of the fund’s shares trade openly throughout the day. This also allows investors to nab shares at a discount to the funds NAV, inviting opportunities for price appreciation.
The Cons of a Closed-End Fund
While there’s a lot of upside to closed-end mutual funds, there are some drawbacks. Namely, there’s not always great liquidity. A finite number of shares are only available through brokers, and usually only through the fund’s sponsoring investment company. If there aren’t any shares currently available, investors can’t buy in. And, while they wait, the price of shares can change with relative volatility to the broader market.
How to Make Money Through a Closed-End Mutual Fund
There are two primary ways to make money through a closed-end mutual fund: distributions and price appreciation. Buying at a discount to the NAV invites the potential for gains as the share price appreciates over time. And depending on the fund you buy into, the potential for capital gains and dividend distributions is high. Either way, you’ll have the peace of mind in knowing that you own shares in a fund that’s professionally managed and structured through a limited number of shares. Just make sure you’re aware of the expense ratio and the track record of the fund manager.