People often get confused between Open-Ended Mutual Funds and Closed-End Funds, and think they are the same. However, they are quite different from each other. Closed-End Funds are sold directly by companies, through IPO or Initial Public Offering. Anybody interested in buying these funds can purchase them from the selling company. One must know, that only a limited number of shares are sold via the IPO, and unlike open-ended mutual funds, these cannot be sold back to the issuing company. Closed-End Funds are bought and sold via the Stock Exchange.
The Concept of NAV
NAV refers to the Net Asset Value. This NAV determines the price of a share. In closed-end funds, the price of a share is not equal to NAV. It can be above (at a premium to), or below (at a discount to) its NAV. The transactions based on the market price, of course depend on the demand and supply forces in market.
Buying and Selling
In Closed-End Funds, buyers have some deciding power in their hands, and are able to negotiate on the prices of shares. Usually, when bought at the IPO prices, the investors get some discounts. Some investors are quite smart, as they buy the shares at a discounted price, and then sell them ahead at a premium. However, the good thing is that these funds are known to be professionally managed, and give numerous options to the investors to generate capital growth, and income/ profits through portfolio performance.
Advantages Of Closed-End Funds
CEFs are known to have quite a lot of advantages. The biggest benefit is that of ‘Diversification’. This means that one can spread the market risk by having a portfolio that participates in many securities. So even if one of them goes bad, it would not affect the complete investment badly. In other words, a person still has time and options to recover from the damage or loss. Moreover, these funds are managed and handled professionally, which means that one can invest in them without having to spend a lot of time on research. The professional manager or team of managers does that.
Closed-End Funds can be purchased through the regular form of brokerage accounts, either individual or joint, as is the case with other kinds of custodial, trust or retirement plan accounts. This obviously is a benefit.
One’s Own Eligibility
Anybody can indulge in the buying and selling of CEFs, as long as they have decent capital for the same. As is the case with most investments, it is advisable to not invest one’s entire money in CEFs. A short term loan may prove to be a good secondary option at this stage. For that matter, anything related to the stock markets should be based on a limited capital, to avoid worst-case scenarios when the markets go bad.
Since Closed-End Funds are listed on the market, it is obvious that the companies need to obey certain rules and fit in some criteria in order to be listed. Hence, stockholders can easily expect some transparency with regards to the management. They can even complain against the same, if the need arises.
About the Author: Thomas Green is the author of this post. For more information on finance and investment, follow him on twitter @QPDL_Thomas.