Intuition tells us that a mutual fund's net asset value (NAV) (the net value of all assets within the mutual fund's portfolio divided by the number of outstanding shares) should be identical to its market price, but often, the market price of a closed-end mutual fund (a fund with a fixed number of issued shares that can't be altered) will trade either above or below its NAV.

When this situation occurs and the fund is trading above this price, it is said to be trading at a premium; conversely, when the fund is trading below this price, it is said to be trading at a discount. Here are some possible reasons for why these funds trade at premiums or discounts:

Supply and Demand

The fundamentals of supply and demand will adjust the trading price of a mutual fund compared to its NAV. If the fund is in high demand and low supply, the market price will typically exceed the NAV. If there is low demand and much supply, the market price will usually be lower than the NAV.

Management Team

Another reason why there may be a price deviation between the NAV and market price is the management team responsible for the fund itself. Sometimes, if the manager is highly regarded, a premium will be paid by investors wishing to hold the fund. If the management is not as highly regarded, the fund may trade at a discount.

Expectation

Similar to a stock, the expectation that a mutual fund will perform well may affect whether the market price is above or below the NAV. Portfolios expected to perform well in the near future will demand a premium to NAV, while those with assets expected to perform poorly may sell at a discount.

To learn more, read: An Introduction to Closed-End Mutual Funds.

Advisor Insight

Jamie Ebersole, CFP®, CFA
Ebersole Financial, Wellesley Hills, MA

Because closed-end funds trade on a public exchange, the price of the units will be determined by the market. As such, at any point in time the price may trade at either a premium or discount to the stated NAV. Over the longer term, the share price and the NAV should converge.

There are many times when closed-end funds trade above or below NAV when there is no discernible reason for the difference to exist. Normally, though, the differences will be based upon the perspective of the buyers and sellers and their expectations for the future performance of the assets.

For example, if you are looking at a long term municipal bond fund and investors are expecting interest rates to decline to a level that is lower than the current level, you may see the fund trade at a premium.