7

What are the pros and cons of investing in a closed-end fund, as opposed to a traditional mutual fund?

3

Pro:
- Faces less redemption pressure and hence the Fund Manager can focus more on long term gains rather than immediate gains.
- Works well in emerging markets.
- Less churn out in case the market falls sharply, there by making more money in long run.

Cons:
- No additional money to invest/take advantage of market situation.
- Less liquid for investor as he is locked in for a period.

3

The pros and cons of investing in a closed end fund both stem from the fact that the price per share is likely to differ from the net asset value (NAV) of the underlying assets.

That could work to your advantage if the fund is selling for LESS than NAV, or at a discount. Then you get the "benefit of the bargain" and hope to sell the shares in the future for "par" or even a premium (MORE than NAV).

On the other hand, if you buy such a fund at a premium, you stand to have a RELATIVE loss if the value of the fund goes back to par (or a discount) compared to NAV.

That's because a closed end fund has a FIXED number of shares, with the assets continually being reinvested. In essence, you are "buying out" an existing shareholder of the fund at a price determined by supply and demand.

This differs from an OPEN end fund, in which your contribution creates NEW shares (all other things being equal). Then the fund, has to invest YOUR money (and charges you a fee for the service) on exactly a pro rata basis with other investors in the fund, meaning that you will enter and exit such a fund at "par."

In either case, your return depends mainly on the performance of the underlying assets. But there are premium/discount issues for investing in a closed end fund.

2

One advantage not pointed out yet is that closed-end funds typically trade on stock exchanges, whereas mutual funds do not. This makes closed-end funds more accessible to some investors.

I'm a Canadian, and this particular distinction matters to me. With my regular brokerage account, I can buy U.S. closed-end funds that trade on a stock exchange, but I cannot buy U.S. mutual funds, at least not without the added difficulty of somehow opening a brokerage account outside of my country.

  • Hi Chris, if the closed end fund is trading 'openly' on a stock exchange like an ETF, in what sense is it 'closed'? Can you elaborate? – Victor123 Apr 15 '15 at 12:55
  • 1
    @Victor123 Closed to new investment. i.e. no new units are created when you buy a closed-end fund on the stock exchange. You are buying units that already exist from another person that held them. Regular mutual funds issue new units to new investor purchases, and redeem units on investor sales. Hence, open-end. The big consequence is that closed-end funds end up trading at significant premium or discount to NAV. – Chris W. Rea Apr 15 '15 at 13:05
  • 1
    @Victor123 You're welcome. BTW, in the context that you used "openly" in your first comment, I would have instead written "publicly", as in "traded on a public exchange", the more idiomatic way to express that particular concept. Since many terms in finance are overloaded, it's best to know which ones carry less ambiguity in a given context. – Chris W. Rea Apr 15 '15 at 13:34

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.