CLOSED-END FUNDS: MEANING, EXAMPLES & DIFFERENCE [Complete Guide]

An overview of closed-end fund types and operations is provided in this article. However, because each closed-end fund is unique, investors should research a particular fund before investing. Like all investments, closed-end funds carry risk, including the potential for principal loss.

What Is A Closed-End Fund?

A closed-end fund is a type of fund that raises capital by issuing a set number of non-redeemable shares and then invests that money in securities like stocks and bonds. In contrast to open-end funds, managers of closed-end funds do not issue additional shares to satisfy investor demand.

Note that, along with mutual funds, exchange-traded funds, and unit investment trusts, closed-end funds are one of the four categories of investment companies that are registered under the Investment Company Act of 1940. Additionally, a closed-end fund’s assets, which can include stocks, bonds, and other assets, are expertly managed following the fund’s investment objectives and policies. Similar to other publicly traded securities, the market price of closed-end fund shares varies according to supply and demand in the industry.

Lastly, a subset of closed-end funds, which are interval funds, are funds that are permitted to continuously offer their shares and to make offers to repurchase shares at net asset value (NAV) regularly under Rules 415 and 486 of the Securities Act of 1933 and Rule 23c-3 of the Investment Company Act of 1940, respectively. 

How Does Closed-End Funds Work

Firstly, similar to many mutual funds, a closed-end fund has a professional manager in charge of the portfolio who makes active purchases, sales, and asset holdings.

Secondly, the price of its shares changes throughout the trading day, just like any stock or ETF. However, neither the parent company of the closed-end fund nor the fund itself will repurchase shares.

Finally, closed-end funds distribute profits from operations to their shareholders and charge an annual expense ratio. Additionally, the Securities and Exchange Commission requires that businesses that offer closed-end finds must be registered.

What Are Examples Of Closed-End Funds?

Municipal bond funds are the largest category of closed-end funds in terms of assets under management. These sizable funds make investments in the debt obligations of local, state, and federal governments. These funds’ managers frequently look for broad diversification to reduce risk but may also use leverage to increase returns. Additionally, managers create closed-end global, international, and emerging markets funds that combine securities from the stock and fixed-income markets. 

Note that: 

• Global funds mix domestic and foreign securities. 
• International funds only invest in non-American securities. 
• Emerging market funds concentrate on internationally volatile and quickly expanding sectors and regions.

Furthermore, the Eaton Vance Tax-Managed Global Diversified Equity Income Fund ranks as one of the biggest closed-end funds (EXG). It was established in 2007, and as of June 2022, its market cap was $3 billion. Current income and gain generation are the main investment goals, with capital growth as a secondary goal.

Why Is It Called Closed-End Fund?

It is called a closed-end fund because it is a specific kind of mutual fund that raises money for its initial investments by issuing a set number of shares through a single initial public offering (IPO). After that, its shares can be bought and sold on a stock exchange, but no new shares or funds will be generated for the fund.

What Are The Advantages Of A Closed-End Fund?

Closed-end funds have several distinct benefits that support investors in achieving their financial goals.

#1. It Provides Professional Portfolio Management

It provides investors with access to professional portfolio managers as well as low-cost, extensive investment research, and management expertise that is unavailable to them.

#2. It Provides Stable Asset Base

Closed-end funds provide portfolio managers with a stable asset base to invest in securities, allowing them to follow the fund’s investment strategy without managing inflows or redemption requests.

#3. It Offers Trading Flexibility

Investors can make investment decisions using real-time information to buy or sell closed-end fund shares.

#4. Distributions Of Earnings

Investment funds distribute earnings to shareholders in two ways: income is passed through as interest or dividends, and capital gains are realized.

#5. Closed-End Funds Offers Leverage

Closed-end funds can use leverage to amplify investment performance by producing outsized gains or enhancing earnings. It can be done in two ways: borrow capital or issue preferred shares. Therefore, if borrowing costs are lower than net long-term interest rates and the markets are rising, fund shareholders will see greater returns. However, if borrowing costs increase or the markets decline, fund returns may suffer.

#6. Reduced Expense Ratios

Closed-end funds have lower expense ratios than open-end funds, leading to lower fees over time. This is due to the fixed number of shares.

How To Buy Closed-End Funds

You can buy these funds through a brokerage account, but you must first consider:

• What sort of fund are you seeking? U.S.-only securities? Dividend securities? Worldwide stocks?
• How has it performed over time? Most financial websites have information on long-term fund performance. Remember that past success does not guarantee future success.
• What is the fund’s current and typical discount to net asset value? This gives you a notion of the potential reduction in the discount.
• What is the expense ratio for the fund? Beware of sticker shock because this ratio will typically be higher than the expense ratio of an open-end fund.
• What kind of dividend does the fund offer? 
• How much debt has the fund incurred? The fund is riskier when it has too much debt. Risk is significantly increased when debt exceeds 30% to 40% of the fund’s assets.

Before choosing which funds to purchase, you should look into each of these areas if you come across any that seem promising.

Are Closed-End Funds A Good Investment? 

Along with open-end funds, closed-end funds are the two main categories of mutual funds. Closed-end funds have to work harder to gain your favor because they are less well-liked. If you adhere to one simple rule, they can be a good investment—possibly even better than open-end funds.

The Best Closed-End Funds To Buy In 2023

Now let’s look at the top closed-end funds to invest in for 2023.

#1. Eaton Vance Municipal Income 2028 Term Trust (ETX)

The Eaton Vance Municipal Income 2028 Term Trust (ETX) is a tax-free municipal bond CEF with a shelf life and intends to cease its investment operations on or about June 30, 2028. Term funds liquidate at net asset value, giving investors a degree of safety. At current prices, ETX trades at a 4.7% discount to net asset value and yields a tax-free 4.0%. 

#2. BlackRock 2037 Municipal Target Term Trust (BMN)

The BlackRock 2037 Municipal Target Term Trust (BMN) is a target term fund with an objective to liquidate on or around Sept. 30, 2037, and return $25 per share. It trades at a 3% discount to net asset value and yields 4.5%, assuming a 32% tax bracket.

The BMN fund was just established; it went live in late October 2022. The fund was able to expand its portfolio at an ideal time when long-term yields were reaching multi-year highs. 

#3. BlackRock Floating Rate Income Trust (BGT)

The most important details are that floating-rate securities have regular resets that tie the coupon payment to prevailing market interest rates and that the BlackRock Floating Rate Income Trust’s (BGT) portfolio is expected to have an average effective duration of 1.5 years. This means that a 1% rise in market interest rates would translate to 1.5% in capital losses or 1.5% in capital gains.

You are purchasing BGT’s assets for 89 cents on the dollar at the current price, which represents a massive 11% discount to the net asset value. Additionally, it yields an extremely alluring 8.3%.

#4. BlackRock ESG Capital Allocation Trust (ECAT)

Companies with good ESG policies tend to perform better than their peers, particularly on social and corporate governance issues. BlackRock ESG Capital Allocation Trust (ECAT) is required to invest at least 80% of its portfolio in these companies. 

ECAT is a multi-asset fund with 64% allocated to stocks and 47% to fixed income, with 111% allocated to derivatives and options. ECAT currently yields an astounding 8.2% and trades at a huge 16% discount to the net asset value.

#5. BlackRock Utilities, Infrastructure, & Power Opportunities Trust (BUI)

BUI is a balanced, income-oriented equity closed-end fund that invests in equity securities issued by companies in the utilities, infrastructure, and power opportunities sectors. It also offers options to generate additional income. Its largest holdings include renewable energy companies and blue-chip pipeline operators. 

BUI maintains a relatively conservative stock portfolio and uses leverage sparingly. The fund yields 6.6% and trades at a respectable 5% discount to net asset value at the moment.

What Is An Open-End Fund?

An open-end fund is a collective investment plan that has unlimited authority to issue and redeem shares at any time. Instead of buying shares from the current shareholders, an investor will typically buy shares of the fund directly from the fund. There is no cap on how many shares a closed-end fund can issue. Consequently, more shares are issued when you buy them. The open-end fund will purchase your shares if you decide to sell them.

Open-end fund shares are purchased at their Net Asset Value (NAV), which is the total market value of the assets held in the fund at the end of each trading day, minus liabilities, and divided by the total number of outstanding fund shares. NAV can change daily as stock market prices fluctuate during trading hours, reflecting how a fund performs on any given day.

Examples of open-end funds comprise traditional mutual funds, hedge funds, and exchange-traded funds (ETFs), which are investments that trade on a stock exchange. These funds are available for purchase and sale through taxable brokerage accounts, individual retirement accounts, and employer-sponsored retirement plans.

What Is the Difference Between Open-End And Closed-End Funds?

Fundamentally, closed-end funds are distinct from open-ended funds. The main difference between open-end and closed-end funds is how they are purchased and sold. Open-end funds trade at the end of each trading day at their NAV, whereas closed-end funds trade more like stocks, driven by supply and demand.

Furthermore, open-end mutual funds only price their shares once per day, at the close of trading, and they base that price on the portfolio’s net asset value. A closed-end fund’s stock price changes in response to market forces like supply and demand as well as the shifting values of the fund’s holdings.

Lastly, closed-end funds can only be bought and sold using a brokerage account since they only trade on secondary markets, while open-end funds can be bought directly from the investment firm that sponsors the fund.

What Is A Mutual Fund?

A mutual fund is a collection of funds that are professionally managed by a fund manager. It is also a trust that invests money in stocks, bonds, money market instruments, and/or other securities after collecting funds from several investors who have similar investment goals.

What Is The Difference Between Mutual Fund And Closed-End Fund? 

Similar to open-end funds, mutual funds also generate new shares whenever an investor purchases them. Closed-end funds, on the other hand, are closed, in that money does not typically flow into them when investors buy shares or out when investors sell shares.

What Is Nuveen Closed-End Funds

Nuveen is the top closed-end fund supplier in terms of AUM (Assets Under Management). Due to their unique structure and capacity for using leverage, closed-end funds may have a higher potential for regular income than other types of investment products.

Do Closed-End Funds Expire? 

A new fund offer (NFO) is created by an asset management company (AMC), and investors buy units of the scheme at a set price. There is no more room for new investors after the NFO period has ended. In addition, investors are not permitted to withdraw their money before the plan is fully developed. When a scheme reaches maturity, it is dissolved, and investors receive their money back at the NAV (net asset value) in effect on that day.

Note that investors may trade their units on stock exchanges if they want to withdraw from the scheme before the maturity period expires.

Can You Sell A Closed-End Fund? 

All forms of brokerage firms, including full-service brokers, discount brokers, and online brokers, allow you to buy or sell closed-end funds. You give your brokerage company a commission in each instance as payment for the services.

What Are The Risks Of A Closed-End Fund?

#1. Market Risk: 

The market price of each CEF will be significantly influenced by the market value of the securities it holds. Even the best investment manager cannot completely eliminate losing streaks. A CEF’s value could decrease significantly if the specific securities or industry on which it focuses experiences a significant value decline.

Therefore, you must be aware of the benefits and drawbacks of investing in a particular industry. You might inquire with your advisor regarding the sector’s relationship to the overall market.

#2. Leverage Risk: 

Closed-end funds can typically use leverage to increase returns, but not always. The maximum amount of leverage that a fund is permitted to use is regulated by the industry, but some funds use leverage much more aggressively than others. When leverage is used, it is typically produced by issuing preferred stock or bank loans. Leverage usage by a fund will probably increase the volatility of the market price for the fund. Leverage will make any portfolio losses for the fund more noticeable. 

Therefore, you should be aware of how much leverage a specific fund intends to use. You might inquire with your advisor as to what market or economic circumstances might make the use of leverage detrimental to the performance of your funds.

#3. Liquidity Risk: 

Funds listed on stock exchanges may not always have sufficient liquidity, affecting their market value. You should be aware of the level of liquidity that is or is anticipated to be available for a specific fund. Asking your advisor about the size of the market price discount that resulted from a historically significant price decline and the length of time it took for prices to recover

#4. Manager Underperformance Risk: 

Professional management of the fund’s portfolio is beneficial, but the risk of underperformance is higher. Newer, smaller management companies may outperform larger, more experienced managers, but the risk of underperformance is higher.

#5. Foreign Investment Risk: 

Closed-end funds investing in foreign securities are subject to currency and exchange-rate risk, governmental regulation, policy, and taxation, as well as political, social, and economic instability, especially in emerging growth countries.

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References: 

Bankrate

Nerdwallet

Investopedia