Closed-End Funds (CEFs)
Exchange Traded Funds
Closed-End Funds (CEFs)
A closed-end fund is a publicly traded, professionally managed, investment
company, designed to manage a fixed pool of capital for its investors.
CEFs normally have clear
There are three general
types of closed end funds:
- Bond Funds
Ė These are the largest types of CEFs. The tax-exempt municipal bond funds
are the most popular funds in this category. Bond funds pay good dividends
and invest in long-term debt instruments. They provide solid returns, with
secure and stable principal values.
- Equity Funds
Ė They employ various capital appreciation strategies and income producing
- International and
Emerging Market Funds Ė They
invest in specific geographical locations, and are particularly suited for
investors looking for foreign exposure. These single-country portfolios
are very attractive investment vehicles.
Defining Features of
- CEFs are portfolios
of investments run by investment professionals. These funds are governed
by boards of directors, who appoint investment advisors and portfolio
- Closed-end funds have
a stable capital base, and are evidenced by a relatively fixed number of
shares outstanding. These funds raise capital by selling shares,
(typically in an IPO or through secondary offerings), rights offerings, or
the issuance of shares for dividend reinvestment. Subsequent trading of
shares is done on the stock exchanges, not through the fund. The trading
of shares in the secondary market has no effect on the fundís cash flow.
This results in a constant, and more manageable, inflow and outflow of
- The stock values
trade independent of the fundís net asset values. The fund price can sell
at a discount or premium to its net asset value. The ranges vary, normally
from a 5% premium to a 25% discount of net asset values. Typically, CEFs
sell at a discount, but donít automatically rule out CEFs selling at a
premium. Their investment mix may contain a valuable asset not reflected
in their NAV. Conversely, not all CEFs selling at a discount are bargains.
You may, however, be able to find a fund trading at an unusually large
discount, which may be an excellent buy. You need to be inquisitive!
- CEFs can leverage
their balance sheets. CEFs are run like corporations; they can enhance
their returns by leveraging their capital. This is accomplished by the
issuance of debt or preferred stock, which is hopefully invested in assets
that return more than their cost of funds.
- CEFs can contain
illiquid investments and are suited for the long-term, mainly due to their
fixed capital base. This enables them to be composed of longer-term
securities, such as muni bonds and other debt instruments, emerging market
securities, reorganizations, and private placement deals. While many of
these private deals can be very lucrative, interim reported values may
involve accounting estimates. Illiquid deals can also be very risky and
hard to value.
- CEFs can be purchased
or sold throughout the day. Trading instructions, such as limited and stop
orders, are also available.
- CEFs normally do not
pay corporate income taxes. Like mutual funds, taxes are passed through to
the shareholders. For investors in taxable accounts, any interest,
dividends and capital gains are subject to taxes. CEFs held in tax
deferred accounts, such as IRAs or 401k plans, are not subject to taxes
until the funds are withdrawn.
- Income distributions
are usually clearly defined and made according to a prescribed schedule.
CEFs and Mutual Funds:
Closed-end funds have a
fixed capital structure. Trading of shares is done on the stock exchanges,
throughout the day, without affecting the operations of the fund. Mutual
funds, however, have an open ended capital structure. New purchases and
redemptions are made directly through the fund, processed at the end of each
day, and valued at the net asset value of the fund. Cash is constantly
flowing in and out of mutual funds. A closed end fund can be more focused on
long-term results, while a mutual fund is concerned with the fundís ever
changing cash flow fluctuations.
The nature of the
capital structure of CEFs is more complicated than mutual funds. Mutual
funds are capitalized with equity, while CEFs are capitalized with a
combination of equity, debt and preferred stock.
CEFs are purchased
through brokerages firms; a brokerage account is required, and commissions
and fees are involved. Mutual funds can be load or no load. Both funds have
expenses. Mutual funds, however, have higher marketing and back-end fees.
CEFs normally have lower expenses.
Purchasing CEFs at an
initial IPO may or may not be a good idea. Investors purchasing IPO shares
might or might not pay commissions. Any commissions, along with all the
other underwriting and offering expenses, are deducted from the IPO
proceeds. This is a major upfront cost that reduces the fundís net asset
value and ultimately its share price. Just be careful.
CEFs can be purchased or
sold at discounts or premiums from the fundsí net asset values (NAV). Open
end mutual funds always trade at the fundsí NAV.
CEFs can pay higher
yields. These funds have lower expenses. They also do not need to keep extra
cash on hand, or to sell securities to fund redemptions. Additionally,
yields are not diluted by an unexpected influx of cash.
CEFs normally have more
conclusion, CEFs can be excellent investments. Investors just need to get
comfortable with the discount/premium feature.