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Researching Closed-End Funds

April 19, 2014

Closed-end funds (CEFs) are similar to traditional open-end mutual funds in that professionally managed investment companies pool investors’ capital and invest in stocks, bonds or other securities according to an overriding investment objective. However, there are several key differences between closed-end funds and open-end funds that investors should be aware of. Closed-end funds trade on an exchange similar to exchange-traded funds (ETFs), but they are valued differently. Closed-end funds are essentially a mix between a mutual fund and a stock; they have a net asset value (NAV) and a share price. Closed-end funds do not issue redeemable shares nor do they continuously offer shares, which allows fund managers to work with a stable pool of capital. Closed-end funds have an initial public offering, much like a start-up company. After the initial public offering is closed, the fund’s shares will begin to trade on a secondary market.

The discount or premium on a closed-end fund represents the percentage difference between the share price and the portfolio’s underlying net asset value. Discounts and premiums are determined by the favorability and perception of the closed-end fund by investors in the market. Just as with stocks, investors must gauge the benefits and risks associated with investing in a closed-end fund trading at a premium or a discount. It’s important to track historical valuations to analyze whether the fund is offered at a discount or if its price actually reflects its value. There is always a chance that you will have to sell the fund at a deeper discount than when you purchased it. Therefore, liquidity is a caveat. A fund may have a premium if investors are confident in the fund, the managers’ ability or the underlying securities (and vice versa). Investors should also consider factors such as management, performance, volatility and expenses.

Investors make money by purchasing a closed-end fund at a discount to its net asset value, and selling when spread between the price and net asset value shrinks. Closed-end funds typically pay monthly or quarterly dividends, which could be attractive for investors seeking a stream of income. Expenses and fees will play an important role in total return, so keep an eye out for steep fees.

Investors need resources not only for data on closed-end funds, but also to educate themselves on how the funds operate in order to properly implement them into their portfolio. The following websites are the places to visit for more information.

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