Closed-end funds are related to open-end funds in organizational structure and are the original investment instruments. They offer investors several significant advantages over open-end or mutual funds. To understand this, keep in mind the meaning of the term Net Asset Value (NAV). The NAV of any fund is based on the sum of the market values of all the fund's security positions, plus its cash and minus its liabilities.
Limited number of shares: Closed-end funds (CEFs) have a limited number of shares because of their fixed capitalization. Open-end funds are constantly redeeming and issuing new shares.
Trading: The number of shares a closed-end fund has is limited. Closed-end funds and exchange-traded funds (ETFs) trade on a stock exchange while open-end funds do not. Open-end funds continuously offer shares to investors at NAV plus any front-end load or sales charges. They can redeem investor shares at NAV, net of redemption charges or back-end load.
Because they are not tied to NAV, the price of a closed-end fund trades above or below its net asset value. This results in a premium (above NAV) or a discount (below NAV) allowing the closed-end fund investor to buy and sell at known prices using limit orders, a major advantage.
Lower expenses: Closed-end funds usually have lower expense ratios in part because they do not have the extra fees that open-end funds may levy in order to pay for marketing the fund.
Inefficient market: Information about closed-end funds is not always available, often creating price inefficiency in a relatively efficient marketplace. This provides an opportunity for sophisticated investors to garner above-average, long-term results.
No inopportune cash flows: Closed-end fund portfolio managers do not need to worry about ill-timed redemptions. When investors in open-end funds want to add money to those funds whose NAV is rising and withdraw it when it is performing poorly, they may force the open-end fund manager to buy when the value of the fund is rising or to sell when the value of a security is falling. This is what "Investing 101" teaches us NOT to do and is one of the primary reasons why we think CEFs often outperform their open-end counterparts.
Higher volatility: Closed-end funds tend to be more volatile than open-end funds. While the NAV volatility should be the same for both fund types, the price volatility of a closed-end fund tends to be higher because of its market price and the fluctuation of the discount/premiums. This allows investors to buy or sell the fund's shares at better prices.
Leverage: Buying a fund at a discount gives the buyer leverage free-of-charge since it can amplify profits. We call buying a fund with a NAV of $10 at a discount of 10% “buying 90¢ dollars”. The leverage works so that investors can earn income and appreciation on a full dollar’s worth of assets, for an investment of 90¢.
A closed-end fund, which borrows money, has the ability to enhance the fund’s yield. The additional yield comes at the expense of higher volatility. The leveraged fund has historically outperformed the unleveragd fund in a bull market, though it may underperform in a bear market. Few closed-end funds actually borrow money.
Another kind of leverage, particularly in the tax-free variety of closed-end funds such as those issued by a firm like Nuveen, are leveraged through the issuance of preferred shares, commonly 30% or 40% of the fund’s total capital.
Liquidity: Some closed-end funds are small in size, and their shares do not trade in large volumes. This can be a problem for investors, but we overcome it by being patient and buying when others are selling and selling when others are buying. Utilizing limit orders lets you wait for the shares to come to you.
Prospectus: Unlike mutual funds, closed-end funds only have to issue a prospectus before they go public, like other publicly-traded companies.
If you are looking for an investment manager who has a depth of knowledge and experience and who has a strong, consistent record of making good, long-term returns in an increasing difficult environment, we would like to talk to you and go over your portfolio and investment objectives to see if we can be of service.
For more information on closed-end funds, please visit the following sites:
|The Closed-End Fund Association:||www.cefa.com|
|Capital Link’s Closed-End Fund Forum:||www.closedendfundforum.com|
|Site-By-Site Closed-End Funds:||www.site-by-site.com/usa/cef/cef.htm|
Closed-End Funds: A World of Investment Opportunity
Today there are more than 850 closed-end and exchange-traded funds worldwide, mostly trading on the New York Stock Exchange and representing every segment of the markets of the world.
Closed-end equity funds in the U.S. include blue chip investors, small-capitalized growth funds and specialty funds such as those in health care, energy, real estate and utilities. Corporate bond funds, including multi-sector funds and convertible bond funds, are the largest sector.
Our specialty is the closed-end fund structure for global investing. It is particularly well-suited for country funds in the less liquid emerging markets. Some open-end funds invest in these smaller markets, but we think investors who buy mutual funds in the less developed countries take too much risk in these largely illiquid markets.
Investors can profit in two ways from investing in a closed-end fund. First, by identifying a fund with the potential to increase in value, a profit can be made by a rising net asset value. As this value grows and is noticed in the marketplace, there is a tendency for the discount to narrow, providing higher share prices. Investors must realize they can make a profit in the fund even if the discount doesn’t narrow.
Some closed-end funds are excessively concerned with the discount. Many CEFs have successfully reduced their discount and enhanced performance by a combination of share repurchases and/or periodic tender offers at or near NAV.
ETFs are baskets of index shares, which trade at or near net asset value and are similar in structure to closed-end funds. Although we haven’t been using ETFs in our portfolios, we are considering them, as they are a way to enter some markets not covered by closed-end funds.