Investing in Closed End Funds

There are two common variations of the popular

mutual fund; closed end and open end funds. Here’s

a look at closed end funds.

A closed-end (mutual) fund is an investment vehicle that is easily compared to an open-end mutual fund,

a common investment product that most investors are familiar with.

Closed-End vs. Open-End Funds

When most investors mention a mutual fund, theyre referring to an open-ended mutual fund, a type of

investment you can buy and sell on a daily basis directly from the fund company issuing the fund. The

price of the open-ended mutual fund is based on the net asset value (NAV) of the fund. Net asset value is

the price per share.

Closed end funds on the other hand are sold directly from the company once in what’s called an initial

public offering (IPO). Only a limited number of shares of the closed end fund are sold via the IPO. Shares

of these closed end funds can be bought and sold after the IPO, but only on the secondary market from

an investor whos already purchased the shares. Because closed end funds cant be sold back to the

company who issued the fund, they must be sold via a stock exchange.

Unlike an open end fund, the price of a closed end fund isnt equal to the NAV. Rather, the price of a

closed end fund is sold at a premium or discount dictated by the open markets. Buyers tend to have

more negotiating power on the price of closed end funds.

Investors can make money from closed end funds by purchasing them at a discount and selling them for

a higher price. In fact, closed end funds often trade up to 20% below their actual value due to market

volatility. However, its not typical for the price of funds to ever rise to their NAV.

The benefit of a closed end fund is that investors are able to get the benefits of a mutual fund

professional management and diversification but at a lower expense than an open end mutual fund.

Closed end funds have less operating and marketing expenses than their open ended counterparts

since they trade openly on an exchange, much like a common stock.

Bond Funds vs. Equity Funds

Closed-end funds are often classified as bond funds or

equity funds.

Bond funds invest in bonds and debt instruments. Bonds

are like an IOU to an entity like the government or federal

agency. Bond funds might be invested in several

different types of bonds government bonds, corporate

bonds, municipal bonds, etc.

Equity funds are invested in stocks, which are essentially

a partial claim of ownership in a corporation or its

earnings.

Diversified vs. Non-Diversified

Diversified closed-end funds are invested in several different types of securities. Therefore, they are

generally less risky and more stable than their non-diversified counterparts. Non-diversified closed-end

funds are only invested in one type of security. You can find out whether a fund is diversified or non-

diversified by reading the prospectus.

Buying a Closed-End Fund

Its typically better to purchase closed end funds a few weeks to a few months after the IPO. If you

purchase the funds on the day of the IPO, youll end up paying a higher price for the funds. Youll also be

subject to sales commission. Waiting to purchase the fund on the secondary market lets you purchase

shares at a discount rather than at the full NAV.

When you decide to purchase funds, make sure you buy at a discount. That means youre paying less for

the fund than its worth. Buying at a premium (a higher price) is like paying $1.25 for $1.00 it doesnt

make sense.

Consider the funds expense ratio the cost to operate the fund. Look for funds that have an expense

ratio thats equal to or lower than other funds in the same category.

Look at how the fund has performed in the past. Past performance doesnt always mean future

performance, but its still something you should consider when youre purchasing any investment,

including closed-end funds.

Make sure you read the prospectus of the fund before you purchase. The Securities and Exchange

Commission (SEC) requires that this document be made available to all potential investors.