What are Closed-End Mutual Funds?

Posted on Tuesday, July 3rd, 2018 MarketBeat Staff

choosing a closed end mutual fund on a tablet

Closed-end mutual funds (CEFs) are some of the most sought-after investment vehicles, in part because they tend to offer high yields at relatively reduced risks.

What is a Closed-End Mutual Fund?

A closed-end mutual fund, sometimes referred to as a closed-end fund or a CEF, is a type of investment fund that pools funds from investors to invest in an array of financial securities. These sort of publicly traded funds are designed to provide investors with exposure to a larger pool of stocks and other investments  A CEF may specialize in a specific industry, geographic market or sector. There are hundreds of CEFs specializing in various securities from shares of companies to bonds and even commodities.

Traditional mutual funds issue and redeem shares on a daily basis.  Closed-end mutual funds, on the other hand, do not issue or redeem shares daily. Instead, shares are traded on an exchange intraday.

How Closed-End Mutual Funds Work

Closed-end mutual funds raise a prescribed amount of money through an initial public offering, whereby a fixed amount of outstanding shares is normally sold to investors. These types of mutual funds are traded on stock exchanges just like other stocks or exchange traded funds, and their prices change depending on selling and buying pressure.

Because of the limited amount of shares offered in the market, closed-end mutual funds can trade at a premium or a discount, relative to the net asset value.  For instance, a CEF fund becoming popular will most of the time lead to shares trading at a premium leading to a much higher share price compared to the value of the underlying investments in the fund. Closed-end funds that are out of favor normally trade at a discount compared to the net asset value.

Closed-end prices can fluctuate dramatically in a given trading session, leading to unexpected losses, given that forces of demand and supply affect them. While investing in this asset class, it is also essential to pay close attention to expense ratios as they can significantly eat into one’s returns.

Just like mutual funds and ETFs, closed-end funds don’t pay any tax at the corporate level. Instead, any tax liability is normally passed through to shareholders.

Differences Between a Closed-End Mutual Fund and an Open-End Mutual Fund

Open-end mutual funds and closed-end mutual funds differ from one another mostly in how they are structured, bought and sold in the market.  While both of them achieve significant diversification by investing in a collection of securities, investments that make up the fund’s portfolio could also differ significantly.

Companies selling shares directly to investors normally offer open-ended mutual funds. The number of shares that investors can buy is not fixed and is unlimited. In contrast, closed-ended mutual funds come with a fixed number of shares, offered solely through an initial public offering.

An open-ended mutual fund price is fixed by day, depending on the net asset value of the investments that the fund is following. It is at this price that the fund can be purchased on a given day. Closed-end funds, on the other hand, do not come with a fixed price. Given that they trade throughout the day like stocks, their prices tend to fluctuate throughout each day depending on the forces of demand and supply in the market.

Unlike open-ended funds, closed-ended mutual funds can include an array of alternative investments such as futures, derivatives and foreign currency. Closed-end funds are also allowed to invest in a great number of illiquid assets that cannot be sold within a given period.

Open-ended funds buy and sell units on a continuous basis thus allowing investors to enter and exit positions as they find it suits.  The units are normally purchased and sold at the net asset value, declared by the fund. Closed-ended mutual funds, on the other hand, are fixed, and only sell a specific number of units. Investors cannot buy CEF units after the initial offering.

Comparison Closed-End Fund Open-End Fund
Operation

Closed-end funds offer units for a limited period

Open-end funds offer units to investors on a continuous basis

Selling Price

Premium or discount to net asset value

Net asset value plus load

Subscription

CEFs are only available for a specified period

Open-end funds are available throughout the year for a subscription

Maturity

Come with a fixed maturity  period, i.e. 3 to 5 years

There is no fixed maturity  date

Liquidity

Stock market

Funds itself

Listing

Listed on recognized stock exchange for trading

No listing on stock exchange. Transactions performed directly through a fund or company.

Transactions execution

Executed in real time

Executed at the end of the day

 

Which Is Better— Open-End or Closed-End Funds?

Open-end mutual funds are a safe bet for investors looking to trade an asset class that has fewer restrictions. Such types of mutual funds are a preferred choice for normal equity fund investors and debt funds, given the high levels of liquidity they come with.

Open-end funds score higher when it comes to liquidity given that an investor can apply for application and redemption at any given time.  Sale proceeds are normally credited to an account in T+2 days. Closed-end funds, on the other hand, are not liquid as they do not accept fresh applications and redemptions at just any time.

Closed-end funds are ideally suited for investors in need of a fixed maturity plan where invested funds are locked for a given period. In this case, CEFs help reduce the interest rate risk.  CEFs also tend to produce better returns depending on the amount of time an investor’s funds remain locked.

Unlike open-end funds, closed-end mutual funds final returns combine dividend payments as well as capital appreciation, which guarantee a higher payout in the long run. However, they also tend to be risky, given that most of them use leverage as a way of producing higher returns.

Similarities Between ETFs and Closed-End Funds

Closed-end funds and exchange-traded funds share a lot of similarities given that both of them have continuous trading and pricing in stock exchanges. They are thus very liquid options for retail investors looking to gain on price swings.

ETF and CEFs come with an underlying portfolio of investments with a net asset value. The two funds are actively managed, with managers tasked with the responsibility of adding and removing securities from the portfolio depending on their impact on the overall portfolio.

CEF and ETF shares trade much like any other stock in the stock exchange, in that traders can set up limit orders, short the desired amount of shares or even buy on margin.

Depending on management style, the closed-end funds and exchange-traded funds can be leveraged by managers, as a way of maximizing returns. The two also come with expense ratios and fee schedules.

Both offer distributions in the form of dividends as well as capital gains depending on the amount of time an investor invests in them.

Closed-End Mutual Fund vs. ETFs

Comparison ETFs CEFs
Pricing

Intraday

Intraday

Purchase Accessibility

High- any broker can purchase

High- any broker can purchase

Portfolio Accessibility

High

Low

Listed Options

Yes

Some

Tax Efficient

Yes

No

Continuously Offered

Yes

No

Management Type

Passive

Active

 

Is a Closed-End Mutual Fund Right for Me?

Closed-end mutual funds come with lots of synergies that any investor looking to invest for the long term can take advantage of.  Its structure is also beneficial for investors looking to take advantage of certain key market conditions, especially within fixed income.

Closed-end mutual funds are popular investment instruments for income-focused investors because of their large distribution yield, supplemented by capital appreciation and dividend offerings.  Another reason to invest through these asset classes has to do with the fact that they enable access to professional portfolio managers. In addition, investors can take advantage of low cost, extensive research and money management expertise provided by the managers.

The fact that closed-end funds trade in exchanges provides investors an opportunity to buy shares at a price that may be above or below the net asset value of the fund’s holdings. In addition, one can utilize stock trading methods such as market limit orders, stops, short sales and margin trading to generate profits.

Closed-end funds are for investors who wish to make decisions using real-time information given that they can be bought and sold at prevailing market prices.  CEFs also distribute earnings to shareholders at regular intervals through interest and dividends. In addition, one stands to benefit from capital appreciation upon maturity.

CEFs don’t have ongoing costs associated with distribution given the fixed number of shares on offer. It is for this reason they are associated with lower expense ratios, compared to other funds, which lead to lower fees therefore maximum returns in the long run.

10 Best Closed-End Mutual Funds Based On Performance

Below are the top ten closed-end mutual funds that have been delivering market-bearing performance when it comes to income generation.


Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG)

Assets: $3 Billion

One Year Return: -4.48%

Three Year Return: 8%

Eaton Vance Tax-Managed Global Diversified Equity Income Fund is a diversified closed-end management investment company that strives to provide current income and gains as well as capital appreciation. The fund invests in a diversified portfolio of domestic and foreign stocks with an emphasis on dividend-paying stocks.


DNP Select Income (DNP)

Assets: $2.05 billion

One-year return: 16%

Three-year return: 22%

Incorporated in the U.S, DNP Select Income is a closed-end management investment company that invests in equity and fixed income securities of public companies. The fund’s primary objective is growing current and long-term income as well as capital appreciation.


Nuveen Municipal Value (NUV)

Assets: $2.03 billion

One-year Return: 12.73%

Three-year return: 9.6%

The closed-end fund seeks to provide current income from regular federal income tax. The fund invests in an actively managed portfolio of tax-exempt municipal securities.


Kayne Anderson MLP (KYN)

Assets: $2 billion

One-year return: 1.22%

Three-year return: 25%

Kayne Anderson MLP invests in equity securities of energy-related master limited partnerships and other midstream energy companies. Its main objective is to obtain high after-tax total returns.


Aberdeen Asia Pacific Income Fund (FAX)

Assets: $1.9 billion

One-year return: 4.54%

Three-year return: 15.24%

The closed-end mutual fund pursues current income as well as capital appreciation by investing in Asian debt securities, Australian debt securities, and New Zealand debt securities.


Eaton Vance Limited Duration Income (EVV)

Assets: $1.93 billion

One-year return: 5.76%

Three-year return: 14.12%

Eaton Vance Limited Duration Income is a diversified closed-end management investment company that seeks to provide current high-level income. The fund invests in mortgage-backed securities, senior secured floating rate loans, and corporate bonds.


Eaton Vance Tax-Managed Diversified Equity Income (ETY)

Assets: $1.63 billion

One-year return: -1.02%

Three-year return: 8.23%

Eaton Vance Tax-Managed Diversified Equity Income is a diversified CEF that seeks to provide current income and gains by investing in domestic and foreign stocks that pay exciting dividends.


NFJ Dividend, Interest & Premium Strategy (NFJ)

Assets: $1.63 billion

One-year return: -0.01%

Three-year return: 13.17%

The diversified closed-end management investment company strives to provide current income and gains by investing in a diversified portfolio of dividend-paying common stocks and income producing convertible securities.


Cohen & Steers Infrastructure (UTF)

Assets: $1.61 billion

One-year return: 2.7%

Three-year return: 19.27%

Headquartered in New York Cohen & Steers, CEF specializes in real liquid assets including real estate securities as well as listed infrastructure commodities and natural resource equities.  The fund’s main objective is total return with an emphasis on income.


BlackRock Science and Technology Fund (BST)

Assets: $673 million

BlackRock Science and Technology Fund is a closed-end equity fund that strives to provide income and total return through a combination of current income, gains and capital appreciation. The fund invests a good chunk of its capital on equity securities issued by U.S and non-U.S science and technology companies.


Conclusion

Closed-end mutual funds are some of the best investment vehicles when looking for a reliable, long-term stream of income. Capital gains, as well as current income in the form of dividends, make them an exciting pick for income-focused investors. However, it is essential to maintain a close watch on expense ratios as they affect returns.

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