When State Street introduced its famous SPDR S&P 500 fund back in 1993, a huge growth industry was born. Exchange traded funds (ETFs) have become the go-to fund format for many investors looking to access new asset classes and strategies. More than $1 trillion worth of assets now sit in ETFs, and the industry continues to produce new and innovative fund types. However, investors should be aware of ETFs' quirkier cousins.

Often wildly misunderstood, closed-end funds (CEFs) could be a great way to add many of the same strategies and assets available in ETFs, but at discount prices. At first glance, it may seem like ETFs and CEFs are quite similar. However, from an operational perspective, they are actually quite different. For investors willing to give the security type a go, exploiting these differences could lead to gaining access to many American and international blue chips at a fraction of the cost.

SEE: Open Your Eyes To Closed-End Funds

Juicy Discounts to NAV
According to the Closed-End Fund Association, closed-end funds have been available since 1893, more than 30 years prior to the formation of the first open-end fund in the U.S. Yet, the security type is often ignored when constructing portfolios. That's a real shame, as its uniqueness can be used to an investor's advantage.

Investors can think of closed-end funds as a cross between ETFs and traditional mutual funds. Unlike ETFs, which have a creation and redemption mechanism, CEFs are launched through an initial public offering (IPO), which raises a fixed amount of money by issuing a fixed number of shares.

The fund's sponsor invests the IPO proceeds according to the CEF's underlying mandate and then the shares trade on the equities markets. Because the shares of a closed-end fund are bought and sold on the open market, investor activity has no impact on underlying assets in the fund's portfolio. Unlike a traditional mutual fund, which must hold cash for investor redemptions, CEFs can be fully invested in their assets.

This fixed share nature also leads to one of the biggest benefits when it comes to CEFs - buying assets at a discount. After a CEF's initial IPO, supply and demand take over. This allows CEFs to often trade for discounts to their net asset values (NAV) or the value of the funds' underlying holdings (such as stocks, bonds or futures contracts). For example, if a CEF is trading at a 10% discount to its NAV, you effectively get one dollar's worth of assets for 90 cents. By exploiting that discount, investors are able to pick up stocks for pennies on the dollar.

SEE: An Introduction To Closed-End Mutual Funds

Building a CEF Core
While there can be some more complex issues when dealing with CEFs, such as return of capital distributions and leverage, the deep discounts available from many funds could make these eccentricities worthwhile, especially in the blue-chip stock space. Some of the largest discounts to NAV lie within funds that track bedrock companies such as 3M and Nestle. By using CEFs to gain access to these "core" stocks, investors can build their portfolios from the ground up and save some dough.

For investors looking for blue-chip American stocks, Adams Express could be a great portfolio answer. The fund was founded in 1840, originally as a courier service specializing in the transport of stock securities and other related documents.

However, Adams became more of a holding company for various investments and converted into a closed-end fund in 1929. Currently, the fund trades at an attractive 14.58% discount to its holdings. These include portfolio stalwarts Apple and McDonald's. The fund also has a large position in energy-focused Petroleum & Resources, a closed-end fund currently trading at a 52-week average of 13.45% discount.

The eurozone crisis has already caused many leading European multinational firms to trade at historical lows. However, CEF investors can gain access to these leading companies for even cheaper. Deutsche Bank-sponsored European Equity Fund Inc. currently can be had for an additional average 9.6% discount to its NAV. The fund currently holds 48 different European multinationals, with the bulk of its holdings in the consumer and industrial sectors.

Add in a dose of heavily discounted funds in emerging markets - which can be had with the Morgan Stanley Emerging Markets Fund, or in real estate, through the Neuberger Berman Real Estate Securities Income Fund - and investors can assemble a strong core portfolio.

SEE: Choose Your Own Asset Allocation Adventure

The Bottom Line
Exchange traded funds have taken the investment world by storm, offering exposure to a wide range of asset classes and strategies. However, some of the biggest values in the investment space could lie within their quirkier cousins. Closed-end funds offer portfolios that chance to buy assets at discounts to intrinsic values. Nowhere is that more apparent than in the blue-chip stock space.

Related Articles
  1. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  2. Forex Strategies

    These Are The Best Hours To Trade the Euro

    Six popular currency pairs and numerous secondary crosses offer euro traders a wide variety of short- and long-term opportunities.
  3. Mutual Funds & ETFs

    ETF Analysis: United States Brent Oil Fund

    Learn more about the United States Brent Oil exchange-traded fund, the characteristics of the fund and the suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Ultra Bloomberg Crude Oil

    Find out more about the ProShares Ultra Bloomberg Crude Oil ETF, the characteristics of UCO and the suitability and recommendations of UCO for investors.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Hong Kong

    Learn about the iShares MSCI Hong Kong fund, which invests in various equities of companies listed on the Hong Kong Stock Exchange.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Growth

    Take a close look at the Vanguard Small-Cap Growth ETF, which focuses on domestic small-cap equities with a fundamental growth strategy.
  7. Mutual Funds & ETFs

    ETF Analysis: First Trust Dorsey Wright Focus 5

    Take a closer look at the First Trust Dorsey Wright Focus 5 ETF, a unique and innovative fund of funds based on momentum and relative strength.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares National AMT-Free Muni Bond

    Take an in-depth look at the iShares National AMT-Free Municipal Bond ETF, a highly diverse and very popular muni bond fund.
  9. Mutual Funds & ETFs

    Top 5 Bear Market Mutual Funds

    Discover five bear market mutual funds that investors can turn to for generating maximum capital appreciation during a bear market.
  10. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  5. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  6. Sprexit

    Sprexit, or SPanish euRo exit, is the possible case of Spain ...
RELATED FAQS
  1. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  4. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  5. What action is the SEC likely to take on 12b-1 fees?

    The Securities and Exchange Commission (SEC) may take action to impose greater regulation on how 12b-1 fees are used, or ... Read Full Answer >>
  6. What is considered a reasonable 12b-1 fee?

    A reasonable 12b-1 fee is generally considered to be 0.25% of the assets of the mutual fund. The maximum amount allowed for ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!