Closed-End Fund Primer
What is a Closed-End Fund?
A closed-end fund acts a little like a stock, and a little like a mutual fund. Small and large investors contribute money to the fund, much like open-end funds (popularly known as mutual funds). A professional portfolio manager manages the combined assets of the fund, and may invest those assets in stocks, bonds or a combination of both. So in those respects, closed-end funds are very similar to the mutual funds that you are probably already familiar. But unlike open-end funds they have a fixed number of shares outstanding, and closed-end funds have an initial public offering, then they are traded just like a stock.
What are Premiums and Discounts?
Closed-end funds calculate their NAV (Net Asset Value), just like open-end funds. All open-end funds are required to calculate their NAV after the close of trading every day; most closed-end funds calculate their NAV daily, but some still calculate it weekly. Unlike mutual funds, the price of closed-end funds fluctuate based on supply and demand. You can find out the price of a closed-end fund the same way you get a stock price quote.
There are two prices associated with a closed-end fund - the fund's NAV and the trading price of the fund, which is either above (a "premium") or below (a "discount") to the fund's NAV. It is very rare that the price of a closed-end fund is equal to the fund's NAV.
The advantage of buying a closed-end fund at a discount is that if a fund performs well, then investor demand may increase the share price so that the fund trades at a either a lower discount or a premium, thus providing shareholders with the benefit of the market-price appreciation.
Discounts are the main reason why bond investors find closed-end funds so attractive. Many closed-end funds are bond funds, and usually offer higher yields than open-end bond funds because closed-end bond funds pay income out of the shares's NAV, not their market price.
What Else Should I Know?
The topic of closed-end funds is a large one. For more detailed information about investing in closed-end funds, please visit:
A
Guide to Closed-End Funds (Investment Company Institute)
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