What Is a Closed-End Fund?

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DEFINITION

A closed-end fund is a type of investment vehicle that's similar to a mutual fund. It's created with a fixed number of shares that investors can trade on the open market rather than redeem with the fund company.

A closed-end fund is a type of investment vehicle that's similar to a mutual fund. The key difference between a closed-end fund and an open-end fund, such as a mutual fund or an exchange-traded fund (ETF), is that a closed-end fund is created with a fixed number of shares that you trade on the open market rather than redeem with the fund company. That's what gives a closed-end fund its name.

Definition and Examples of Closed-End Funds

A closed-end fund is a type of investment company that pools investor contributions together to buy a mix of securities, such as stocks and bonds. The fund’s managers will make investment decisions in accordance with the stated investment objectives of the fund.

Like mutual funds, closed-end funds can have a variety of objectives. BlackRock’s Core Bond Trust (BHK) is a closed-end fund that seeks to “provide current income with the potential for capital appreciation.” PIMCO’s Municipal Income Fund (PMF) seeks current income that is exempt from federal income tax.

  • Acronym: CEF

How Closed-End Funds Work

Unlike the more popular mutual fund, closed-end funds don't normally buy back shares from investors who want to sell. Closed-end funds sell their shares to investors in an initial public offering (IPO). Investors who want to sell their shares then do so on the open market, similar to the way a stock is traded.

The share price is determined in the open market because closed-end fund shares aren't redeemed with the fund company. It may be different from the value of the securities that make up the fund.

Types of Closed-End Funds

There are many different types of closed-end funds, defined by their investment style or objective. There are closed-end funds that primarily invest in municipal bonds in order to generate tax-free income for investors. Closed-end funds may also focus on taxable, fixed-income investments like corporate bonds, or in specific equity classes such as domestic, foreign, or even specific sectors.

The Cohen & Steers Quality Income Realty Fund (RQI) focuses on real estate securities, with an investment objective of current income and capital appreciation.

Alternatives to Closed-End Funds

Mutual funds and ETFs are similar to closed-end funds. They offer many of the same features. You might want to consider mutual funds and ETFs as well if you’re thinking about investing in a closed-end fund,

Mutual funds and ETFs are open-end funds that offer the same diversification advantages as closed-end funds in that the fund will invest in a broad number of securities. This is usually more than what you could do on your own as an individual investor, especially if you're just starting out and don’t have a lot of money to invest all at once.

Mutual funds and ETFs also have stated investment objectives that you can compare to your own to help you select the funds that will best achieve your goals.

ETFs and mutual funds may also have lower expense ratios than closed-end funds. This can make them more affordable to new investors. The Cohen & Steers Quality Income Realty Fund (RQI) has a managed assets expense ratio of 1.63%, while the Vanguard Real Estate ETF (VNQ) has an expense ratio of 0.12%.

Closed-End Funds vs. ETFs

Closed-End Funds ETFs
Trade throughout the day Trade throughout the day
Expenses include commission and are ongoing and tend to be higher Expenses include commission and are ongoing and tend to be lower 
Pricing departs from net asset value Pricing is at or close to the net asset value
Actively managed Often passively track an index’s performance

Pros and Cons of Closed-End Funds

Pros
  • Diversification

  • Professional management

  • Continual trading

Cons
  • Price volatility

  • Higher expenses

Pros Explained

  • Diversification: Closed-end funds invest in many different securities, so your risk is diversified. No single investment’s loss will usually be enough to create a large impact on your portfolio.
  • Professional management: A dedicated management team will monitor the fund. It will make adjustments to the fund as needed to keep it in line with the fund’s stated investment objectives.
  • Continual trading: A closed-end fund can be traded during the day. You won't have to wait to redeem shares with the fund company at the end of the day as you would with a mutual fund.

Cons Explained

  • Price volatility: The shares trade on the open market, so their prices are influenced by how the market values them rather than their net asset value as with a mutual fund or ETF. That means the share price can be higher or lower than the value of the fund’s underlying investments, adding an additional element of risk.
  • Higher expenses: Like other investment companies, closed-end funds incur operating expenses to manage the fund. These expenses are ongoing. They're expressed as a percentage of the fund’s assets. They may be higher than other investment vehicles’ expenses. That might not make them as easily accessible or affordable for beginner investors.  

Should I Invest in Closed-End Funds?

Closed-end funds may be an appropriate investment for individual investors, but make sure you understand what you’re investing in. Only use money you can afford to lose. You may opt to invest in mutual funds or ETFs instead if a closed-end fund doesn’t seem like a good fit for you.

Always read the fund’s prospectus to determine whether its investment objectives, fees, and risk are right for you and align with your investment goals.

How to Invest in Closed-End Funds

Closed-end funds can be purchased through most brokerage firms, both traditional and online. 

A professional investment advisor can also help you decide whether you should invest in closed-end funds if you work with someone. They can pick some that are a good fit for you and your portfolio.

Browse the available closed-end funds at your brokerage firm if you manage your own investments. You may have access to a screener that could help you sort the options and narrow down your selection. 

Key Takeaways

  • A closed-end fund is a type of investment company that shares many similarities with mutual funds and ETFs.
  • The primary difference is that closed-end funds aren't redeemable with the issuer. The price may vary from the value of the underlying investments.
  • Closed-end funds are professionally managed and trade throughout the day on an exchange.
  • There are many types of closed-end funds with different investment objectives that can provide diversification.
  • Closed-end funds may or may not be appropriate for individual investors, depending on their needs and goals.

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