What is a Closed-End Fund?

I absolutely love these. These are extremely unpopular and the issuance of new closed-end funds this year is at a multi-year low.


What are they?

•  Closed-end funds trade on stock exchanges. You can buy and sell them like stocks. 

• Closed-end funds have a NAV, which stands for Net Asset Value. Closed-end funds selling below their NAV are considered to be at a discount, and those above are considered to be at a premium.

• Their shares at issued at the IPO, then the fund is "closed"; i.e., no new shares are issued, whence the prefix "closed". Note with ETF's shares are created and redeemed.

How can they be beneficial?

•  They let you buy things at a discount. For example a closed-end fund may have an ask price of $10 and a NAV of $9, meaning it is selling at a 10% discount. This basically means you get $1 for free of actual securities whether it be stocks, bonds, or preferred shares.

• They provide leverage. The word leverage instills fear especially after the distant yet recent memory of of the 2009 financial collapse but worry not, it has been proven that closed-end funds with leverage perform better over the long run than those without. 

•  The bond funds provide a high dividend income, especially the leveraged ones.

 What is the downside?

•  Leveraged closed-end funds have much more volatility than non-leveraged funds.

• They generally have high expense ratios. For example the average expense of a leveraged municipal bond is roughly 1.60%. At the same time such a fund usually yields 6% to 7% tax free! Remember they are volatile, if rates rise they collapse.

 Other Remarks

• I would be weary of closed-end funds that distribute any sort of return of capital. One could make a positive argument for this but it reduces the NAV, and I personally don't care for anything that returns capital. It reduces the NAV and thus reduces the value of your investment in the long run.  

• Most municipal bond closed-end funds do not return capital but many taxable high yield bond funds do. Keep in mind the leveraged funds perform better over the long run but they have much more volatility.

• People "say" closed-end fund prices are heavily influenced by individual investors. I can see why this might be true, for example last year Barron's released an article on closed-end fund premiums and they tanked for a few days. Some of the PIMCO funds lost like 20%.

There is a lot more to learn about closed-end funds before buying in my opinion, but I have provided the most important stuff I think. I would recommend that anyone who is considering these check out www.cefconnect.com first.

Remember you don't have to be an expert. There are enough self-proclaimed experts in the world, and when it comes to investing nobody has a crystal ball, nobody knows the future. Use your own judgement and make your own decisions, do not follow the crowd, pick your own!

I hope this post has been helpful to someone out there!