How do closed end funds work?
A closed-end fund is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund.
A closed-end fund is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund.
The NAV of a closed-end fund is calculated by subtracting the fund's liabilities (e.g., fund expenses) from the current market value of its assets and dividing by the total number of shares outstanding. The NAV changes as the total value of the underlying portfolio securities rises or falls.
Answer and Explanation: The correct choice is E. Shares of closed-end funds trade just like stocks.
-Efficient portfolio management. -Ability to control market price and timing. -Leverage potential. Unlike mutual fund managers who must worry about constant inflows and outflows of cash, closed-end fund managers are responsible for a stable pool of capital.
For example, a closed-end fund may invest in securities of very small companies, municipal bonds that are not widely traded, or securities traded in countries that do not have fully developed securities markets.
CEFs that focus on a particular sector or industry group could experience greater price volatility, both up and down. Fixed Income Securities Risk: Investments in bonds and other fixed income securities are subject to interest rate risk and credit risk.
CEF portfolios often hold longer maturity investments, so rising long-term rates will likely diminish a fund's NAV. However, the income from bond coupons is likely to remain intact and available for fund distributions, and bond calls are typically reduced.
CEFs have an underlying portfolio of securities. From this portfolio, a net asset value (NAV) can be derived [NAV = (assets − liabilities) ÷ shares outstanding]. The investment portfolio primarily, if not solely, comprises the assets. For leveraged CEFs, the leverage itself is the bulk of the liabilities.
A closed-end fund's liquidity depends on investor supply and demand, so it can be less liquid than an open-end fund. These funds are also subject to increased volatility because shares can trade above or below their NAV. Another potential drawback is that many closed-end funds use leverage.
Who regulates closed-end funds?
All closed-end funds must meet certain operating standards, observe strict antifraud rules, meet diversification requirements, and disclose complete information to investors. The Securities and Exchange Commission (SEC) oversees regulations under the '40 Act.
A closed-end fund may also distribute return of capital in an attempt to maintain a more stable level of distribution or to support the fund's share price on the secondary market.
Once the shares are sold and the issuer collects the IPO proceeds, the fund's shares trade in the secondary market between investors. Therefore, closed-end funds are negotiable securities.
Similar to a stock, when an investor wishes to purchase or sell shares of a closed-end fund, another investor must be located who wishes to sell or buy these shares. A closed-end fund issues a fixed number of shares at its initial public offering that generally remains constant.
Closed-end funds typically pay distributions on a monthly or quarterly basis. These distributions can include income generated by the fund – interest income, dividends, or capital gains – or a return of principal/capital. A return of principal/capital reduces the size of the fund's assets.
To maintain tax-free status, a CEF must pass on to shareholders, generally speaking, roughly: 90% or more of net investment income from dividends and interest payments. 98% or more of net realized capital gains.
The fee is determined by the fund manager and generally varies between 0.05% to 5.00% of total sales during the IPO. The total amount of the Success Fee is shared by select members of the closed-end fund's selling syndicate. Revenue that MS&Co.
Closed-end funds work similarly, as their shares trade on secondary markets rather than directly through the fund company and thus have a three-day settlement period.
Efficient portfolio management
This means that portfolio managers can keep the fund fully invested and do not have to keep cash on hand to meet redemptions like they would in a open-end mutual fund.
Leverage is a strategy that can be employed by closed- end funds (“CEFs”) in an effort to potentially increase income and enhance returns. The use of leverage is subject to risks, including the potential for higher net asset value (“NAV”) and market price volatility and fluctuations of distributions.
How do closed-end funds use leverage?
To create leverage, a CEF raises capital by borrowing at short-term rates, then uses the proceeds to make additional investments for its portfolio. The fund may also leverage itself by issuing senior securities (preferred shares of the fund) that pay variable or fixed dividends at short-term rates.
As of 2022, there were 441 closed-end funds in the United States, down from 462 funds in 2021.
| Closed-end fund | Distribution rate at market price as of Dec. 14 |
|---|---|
| Ecofin Sustainable and Social Impact Term Fund (TEAF) | 9.4% |
| Eaton Vance Tax-Advantaged Global Dividend Income Fund (ETG) | 8% |
| MFS Investment Grade Municipal Trust (CXH) | 3.6% |
Because closed-end funds and ETFs trade throughout the day on an exchange, the supply and demand for the shares determine their market price; closed-end funds' and ETFs' market prices may fluctuate through the trading day and those prices may be higher or lower than their NAVs.
After the IPO, most closed-end funds are listed on a national exchange such as the New York Stock Exchange (NYSE) or the NASDAQ.
