Why do some closed-end mutual funds trade above or below their net asset values?

Mutual Funds
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November 2016
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Closed-end mutual funds are investment companies that offer shares to the public and are publicly traded on a stock exchange. They differ from open-ended mutual funds in that they have a limited number of shares outstanding and generally do not accept new money after the initial public offering. Thus, they are capitalized once at the beginning of their life and the proceeds are used to purchase a basket of securities that the investment company will manage targeting a specific strategy. Popular strategies include foreign country funds (emerging and developed markets), targeted municipal bond funds,(state level taxable or tax-free, etc.) and diversified stock and bond strategies. NAV (net asset value) is the measure of total assets less any liabilities on the part of the investment company. This NAV number generally represents the book value or net asset value that each share of the mutual fund "owns."

Because closed-end funds are traded on a public stock exchange, the price of the shares will be determined by the market. As such, the share price at any point in time will likely 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 will trade at a premium or discount to 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. This signifies that investors are willing to pay more today to get the future potential appreciation.

If you have a fund that invests in private debt instruments of private companies, and interest rates are going up, you may see the fund trade at a discount to NAV as the market expects there to be write-downs in the value of the debt instruments when future financial results are released. Some funds, such as emerging market funds, may trade at a discount due to the illiquidity of the underlying shares owned by the fund, signifying that investors expect the fund to have a hard time selling these assets at the current prices in the event they were forced to sell. At the end of the day, the discount or premium to NAV boils down to an imbalance in the supply/demand dynamic for the fund and its strategy. If no one wants to own the fund, it is likely to sell at a discount to entice buyers. If everyone wants to own the fund, it will likely trade at a significant premium. Beware, that as the fund is an investment company, it has costs to run its operations, and if they are very high, they are likely to cause the shares to trade at a discount. Also, funds with a very small number of shares will likely have greater fluctuations in their premia/discounts across time. As with all investments, closed-end funds can be a great instrument, but you need to do your diligence and truly understand the finances of the fund and the outlook for the strategy that is being pursued. It is always advisable to discuss an investment in closed-end funds with your advisor before making any investment.

November 2016
November 2016
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November 2016