Bozena Pomponio, BridgeTower Media Newswires
Investors have many different choices of funds when building a portfolio and closed-end funds (CEFs) are one of them. Closed-end funds are a great way for investors to gain broad exposure to multiple asset classes and sectors. However, these funds are not as well known or as popular as their open-end mutual fund cousins. Both have some similarities, but they also have some notable differences.
Closed-end funds issue a fixed number of shares and after its initial public offering, the CEF shares are traded on a national-based exchange. Because CEF shares do not have redemption value, CEF share prices are based on supply and demand and can trade at a price above (a premium) or below (a discount) the full value of a fund’s underlying assets minus its liabilities (a fund’s NAV). A closed-end fund is a unique investment vehicle that allows an investor to benefit from the potential for capital distribution, as well as the ability to oftentimes generate significant levels of income through dividends or other distributions.
Put another way, closed-end funds can be looked at as a mix between exchange-traded funds and traditional open-end funds. When closed-end funds trade at a substantial discount to NAV, they have the potential to outperform open-end funds when a CEF’s discount narrows. Due to this fact, investors who buy shares at a discount are provided a cushion on the downside, while still retaining the upside benefits.
Open-end funds, on the other hand, can issue new shares or redeem existing ones. In addition, shares of open-end funds are purchased directly from the fund and the price is determined by the mutual fund’s net asset value per share. One key benefit to closed-end funds is that shares can be bought and sold at any point during the trading day, unlike a mutual fund transaction where all orders are placed at the close of business and the price is based on the closing NAV.
Another difference between closed-end funds and open-end funds is the fee structure. Most open-end funds charge a 12b-1 fee to cover distribution and marketing costs where closed-end funds have no such fee since they don’t have share redemptions. In addition, open-end funds often charge sales load commission, either front end sales load, back end sales load or both, where closed-end fund have no such charge.
Furthermore, closed-end funds also have the ability to employ leverage, which is used to enhance yields and boost returns to investors. Leverage may be a positive contributor to performance if the rate earned on the investment strategy is higher than the cost of borrowing or issuing preferred shares. Open-end funds are very limited when it comes to leverage since they have strict regulations due to liquidity requirements.
Although the average investor has tended to invest more in open-end funds, closed-end funds provide an attractive option that should be considered. In many cases, an investor could be better served by purchasing a discounted closed-end fund for their portfolio. While open-end mutual funds are often played up in the media, it may be time for long-term investors to give closed-end funds a closer look.
—————
Bozena Pomponio is an Analyst/Portfolio Manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534 (585-586-4680).
