What Is Closed-End Fund?

A closed-end fund is a portfolio of pooled assets that raises a fixed amount of capital through an initial public offering (IPO) and then lists shares for trade on a stock exchange. Other names for a closed-end fund include the "closed-end investment" and "closed-end mutual fund."

Key Takeaways

  • A closed-end fund is created when an investment company raises money through an IPO and then trades its shares on the public market like a stock.
  • Closed-end funds often offer higher returns or better income streams than their open-end fund counterparts.
  • The price of a closed-end fund fluctuates according to supply and demand, as well as the changing values of its portfolio's holdings.

Understanding Closed-End Fund

Like a mutual fund, a closed-end fund has a professional manager overseeing the portfolio and actively buying and selling holding assets. Similar to an exchange-traded fund, it trades like equity, as its price fluctuates throughout the trading day. However, the closed-end fund is unique in that, after its IPO, the fund's parent company issues no additional shares, and the fund itself won't redeem—buy back—shares. Instead, like individual stock shares, the fund can only be bought or sold on the secondary market by investors.

While a closed-end fund has several unique characteristics that distinguish it from an open-end fund, such as a mutual fund or exchange-traded fund (ETF), it also shares several similarities with those two securities. Both closed-end funds and open-end funds are run by an investment advisor, through a management team that trades the portfolio. Both also charge an annual expense ratio and can make income and capital gain distributions to shareholders.

A closed-end fund is organized as a publicly traded investment company, and both it and its portfolio manager need a Securities and Exchange Commission (SEC) registration. It tends to be actively managed unlike most ETFs or index mutual funds, and its portfolio of securities typically concentrates on a specific industry, geographic market, or market sector.

However, closed-end funds differ from open-ended funds in fundamental ways. A closed-end fund raises a prescribed amount of capital only once, through an IPO, by issuing a fixed number of shares, purchased by investors. After all the shares sell the offering is "closed"—hence, the name. No new investment capital flows into the fund.

In contrast, mutual funds and exchange-traded funds constantly accept new investor dollars, issuing additional shares, and redeeming—or buying back—shares from shareholders who wish to sell.

A closed-end funds list on stock exchanges where their shares trade just like stocks with share price movements throughout the trading day. This listing activity contrasts with open-end mutual funds, which price shares only once, at the end of the trading day. While the open-end fund's share price is based on the net asset value (NAV) of the portfolio, the stock price of a closed-end fund fluctuates according to market forces. These forces include supply and demand, as well as the changing values of the securities in the fund's holdings.

Because they trade exclusively in the secondary market, closed-end funds also require a brokerage account to buy and sell. An open-end fund can often be purchased directly through the fund's sponsoring investment company.

Pros
  • Diversified portfolio

  • Professional management

  • Transparent pricing

  • Higher yields than open-end funds

Cons
  • Subject to volatility

  • Less liquid than open-end funds

  • Available only through brokers

  • May get heavily discounted

Closed-End Funds and Net Asset Value

One of the unique features of a closed-end fund is how it is priced. The NAV of the fund is calculated regularly. However, the price that it trades for on the exchange is determined entirely by supply and demand. This investor demand can lead to a closed-end fund trading at a premium or a discount to its NAV. A premium price means the price of a share is above the NAV, while a discount is the opposite, below NAV, value.

Closed-end funds can trade at premiums and discounts for several reasons. They may be focused on a popular sector and reflect the sentiment of that sector. These funds may also trade at a premium if a historically successful stock picker manages the fund. Conversely, a lack of investor demand or a poor risk and return profile for the fund can lead to it trading at a discount to its NAV.

As mentioned earlier, closed-end funds do not repurchase shares from investors, but investors may trade the shares between one another. Because closed-end funds do not redeem investor shares, they don't maintain large cash reserve levels leaving them with more funds to invest. They can also make heavy use of leverage—borrowing capital—to increase returns. As a result, closed-end funds often offer higher returns or better income streams than their open-fund mutual fund counterparts.

Examples of Closed-End Funds

The largest type of closed-end fund—evaluated by assets under management—is municipal bond funds. These large funds invest in debt obligations of state and local governments and government agencies. Managers of these funds often seek broad diversification to minimize risk, but also often rely on leverage to maximize returns.

Managers also build global and international funds with stocks or fixed-income instruments worldwide. These include global funds, which combine U.S. and international securities, international funds, which purchase only non-U.S. securities, and emerging markets funds, which can be highly volatile and less liquid due to the countries where they invest.

One of the largest closed-end funds is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG). Founded in 2007, it has a market cap of US$2.23 billion as of March 2020. The primary investment objective is to provide current income and gains, with a secondary objective of capital appreciation.

Frequently Asked Questions

What Is Unique About the Pricing of a Closed-End Fund?

One of the unique features of a closed-end fund is how it is priced. The net asset value (NAV) of the fund is calculated regularly. However, the price that it trades for on the exchange is determined entirely by supply and demand. This investor demand can lead to a closed-end fund trading at a premium or a discount to its NAV.

What Is an Open-End Fund?

An open-end fund is a diversified portfolio of pooled investor money that can issue an unlimited number of shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares are priced daily, based on their current net asset value (NAV). Some mutual funds, hedge funds, and exchange-traded funds (ETFs) are types of open-end funds. They are the bulwark of the investment options in company-sponsored retirement plans, such as a 401(k).

How Closed-End Funds Differ From Open-End Funds?

A closed-end fund raises a prescribed amount of capital only once, through an IPO, by issuing a fixed number of shares, purchased by investors. In contrast, open-end funds (mutual funds and ETFs) constantly accept new investor dollars, issuing additional shares, and redeeming—or buying back—shares from shareholders who wish to sell. While the open-end fund's share price is based on the net asset value (NAV) of the portfolio and priced once at the end of the trading day, the stock price of a closed-end fund fluctuates due to market forces throughout the trading day. Closed-end funds also require a brokerage account to buy and sell. An open-end fund can often be purchased directly through the fund's sponsoring investment company.