A closed-end fund is an investment vehicle fund that raises capital by issuing a fixed number of shares at its inception, and then invests that capital in financial assets such as stocks and bonds. After inception it is closed to new capital, although fund managers sometimes employ leverage. Investors can buy and sell the existing shares in secondary markets.[1][2][3]

In the United States, closed-end funds sold publicly must be registered under both the Securities Act of 1933 and the Investment Company Act of 1940.[4]

U.S.-based closed-end funds are referred to under the law as closed-end companies and form one of three SEC-recognized types of investment companies along with mutual funds and unit investment trusts.[3]

Like their better-known open-ended cousins, closed-end funds are usually sponsored by a fund management company. The fund's charter, prospectus and the applicable government regulations specify the types of investments the fund manager is permitted to buy. Some funds invest in stocks, others in bonds, and some in very specific things (for instance, tax-exempt bonds issued by the state of Florida in the USA).

Distinguishing features

A closed-end fund differs from an open-end mutual fund in that:

Another distinguishing feature of a closed-end fund is the common use of leverage (gearing) to obtain new money to invest after the fund's inception. This can be done by issuing preferred stock, commercial paper or rights offerings. Leverage amplifies gains when the market prices of the fund's investments rise, but it also amplifies losses when market prices decrease. This increases the volatility of a leveraged fund's net asset value, compared with an unleveraged peer.[6][7]

The amount of leverage a fund uses is expressed as a percent of total fund assets (e.g. if it has a 25% leverage ratio, that means that for each $100 of total assets under management, $75 is equity and $25 is debt). In some cases, fund managers charge management fees based on the total managed assets of the fund, which includes leverage. This further reduces the income benefit of leverage to the common shareholder, while retaining the additional volatility.

Leveraged funds can seem to have higher expense ratios—a common way that investors compare funds—than their non-leveraged peers. Some investment analysts advocate that expenses attributable to the use of leverage should be considered a reduction of investment income rather than an expense, and publish adjusted ratios.

Since stock in closed-end funds is traded like other stock, an investor trading them will pay a brokerage commission similar to that paid when trading other stocks (as opposed to commissions on open-ended mutual funds, where the commission will vary based on the share class chosen and the method of purchasing the fund). In other words, closed-end funds typically do not have sales-based share classes with different commission rates and annual fees. The main exception is loan-participation funds.

Comparison to exchange-traded funds (ETFs)

Closed-end funds are traded on exchanges, and in that respect they are like exchange-traded funds (ETFs), but there are important differences between these two kinds of security. The price of a closed-end fund's shares is completely determined by investor demand, and this price often diverges substantially from the NAV of the fund assets. In contrast, the market price of an ETF trades in a narrow range very close to its net asset value, because the structure of ETFs allows major market participants to redeem shares of an ETF for a "basket" of the fund's underlying assets.[8] This feature could in theory lead to potential arbitrage profits if the market price of the ETF were to diverge substantially from its NAV. The market prices of closed-end funds are often 10% to 20% higher or lower than their NAV, while the market price of an ETF is typically within 1% of its NAV. Since the market downturn of late 2008, a number of fixed income ETFs have traded at premiums of roughly 2% to 3% above their NAV.

Discounts and premiums

Closed-end fund shares often trade at prices that deviate from the market values of the securities in their portfolios. Such funds have a long history of trading at a discount to market value, although they may also trade at a premium.[9][10][11] Reasons for the tendency towards discount pricing are thought to include:

However, financial economists Zvi Bodie, Alex Kane and Alan J. Marcus have opined that the various hypotheses put forth do not fully explain the persistence of discount pricing.[5]: 86 

Recent trends

For calendar year 2022, the weekly financial newspaper Barron's reported that the Herzfeld Average, which quantifies the discount or premium, traded at a discount to net asset value during most of calendar year 2022.[17]

Examples

Among the biggest, long-running closed end funds are:

See also

References

  1. ^ a b Thau, Annette (2001). The Bond Book. New York: McGraw Hill. pp. 340–341. ISBN 0-07-135862-5.
  2. ^ Lemke, Lins and Smith, Regulation of Investment Companies, §9.05 (Matthew Bender, 2014 ed.).
  3. ^ a b c "Closed-End Fund Information". SEC.gov. U.S. Securities and Exchange Commission. 2013-01-16. Retrieved 2015-12-16.
  4. ^ Lemke, Lins and Smith, Regulation of Investment Companies, §5.02[2][b] (Matthew Bender, 2014 ed.).
  5. ^ a b c d Bodie, Zvi; Kane, Alan; Marcus, Alan J. (2010). Essentials of Investments (eight ed.). New York: McGraw Hill/Irwin. p. 85. ISBN 978-0-07-338240-1.
  6. ^ Braham, Lewis (May 1, 2023). "Closed-End Bond Funds Sell at Steep Discounts". Barron's.
  7. ^ Thau p. 340-341.
  8. ^ Investopedia (2015-05-28). "What is the difference between an ETF's net asset value (NAV) and its market price?". Investopedia. Retrieved 2016-12-10.
  9. ^ a b Lee, Charles M.; Shliefer, Andre; Thaler, Richard H. (March 1991). "Investor Sentiment and the Closed-End Fund Puzzle". The Journal of Finance. XLVI (1): 75–109.((cite journal)): CS1 maint: multiple names: authors list (link)
  10. ^ "Investor Sentiment and the Closed-End Fund Puzzle" (PDF). Archived from the original (PDF) on 2010-07-06. Retrieved 2010-12-01. accessed on 31/10/11
  11. ^ Forsythe, Randall. "Play the Closed-End Fund Game with the Pros". Barron's. Retrieved 7 May 2023.
  12. ^ "Lee et al p. 78". ((cite journal)): Cite journal requires |journal= (help)
  13. ^ Herzfeld, Thomas J. (1993). Herzfeld's Guide to Closed-End Funds. New York: McGraw-Hill. p. 8. ISBN 0-07-028435-0.
  14. ^ a b c Herzfeld p. 8-17.
  15. ^ Forsyth, Randall (April 14, 2021). "Play the Closed-End Fund Game with the Pros". Barron's/Dow Jones. Retrieved 7 May 2023.
  16. ^ "Lee et al p. 78-79". ((cite journal)): Cite journal requires |journal= (help)
  17. ^ "Tracking Closed-End Funds". Barron's Market Lab newsletter. December 31, 2022.