Pooled Investments – Closed-end Funds
|There are various types of pooled investments including: mutual funds, collective investment trusts, exchange-traded funds and closed end funds which are available to individual investors. To quickly summarize the major points of each type of pooled investment, check the following table:
| Attributes of Pooled Investment Funds | Fund Type | |||
| Open End Mutual Funds | Collective Investment Trusts | Exchange traded Funds | Closed End Funds | |
| Pooled Capital | Yes | Yes | Yes | Yes |
| Professionally managed | Yes | Yes | Yes | Yes |
| Number of shares or units in existence | Unlimited | Unlimited | Unlimited | Fixed at IPO |
| Shares redeemable by fund company | Yes | Yes | — | — |
| Shares bought and sold on stock exchanges | — | — | Yes | Yes |
| Shares may be traded at any time during market hours | — | — | Yes | Yes |
| Put and Call Options Available | — | — | Yes | — |
| Typical liquidity | N/A | N/A | High | Low |
| Available outside of employers’ pension plans | Yes | — | Yes | Yes |
| Available inside employers’ pension plans | Usually | Usually | — | — |
| Permitted to invest in “illiquid” securities | — | — | — | Yes |
| Actively Managed funds available | Yes | Yes | — | Yes |
| Passively Managed (index) funds available | Yes | Yes | Yes | — |
| Share prices usually close to Net Asset Value (NAV) | Yes | Yes | Yes | — |
| Shares may trade at a premium or discount to NAV | — | — | — | Yes |
| Tax efficiency | Varies | Varies | High | Varies |
| Fees as a percentage of amount invested | Varies | Varies | Low | Varies |
| Employ leverage within the fund | Up to 33% | Yes | Rarely | 33-50% |
Here, we’ll take an in-depth look at closed-end funds.
Closed-end funds (CEFs) share some of the characteristics of the other types of pooled investments, but they have some important differences that may make them attractive to certain investors in certain types of markets.
How Closed-End Funds Differ from Other Pooled Investments
Fixed Share Count
Only Closed-End Funds are so called because at their initial public offering the investment company offers a fixed number of shares. After that fixed number of shares is sold, they are then traded on an exchange just like and individual stock. At that time the offering is closed and no new investment capital flows into the fund. They are the only pooled investment with a fixed share count, all other types issue new shares as required. CEFs, therefore, are more subject to price fluctuation due to supply and demand for the fund shares themselves. CEFs may trade at a substantial premium or discount to their net asset value (NAV). When they trade at a discount, this may make them seem like a bargain – however, that discount might persist for years or even get larger. The long-term average discount to NAV is 3.4% according to Blackrock, but this varies greatly from fund to fund and from time to time. This variability sometimes provides bargain buying opportunities (closed-end fund prices were generally in the dumper in late 2018, averaging a 9.3% discount to NAV), though it may seem more like stomach-churning volatility depending on how you look at it.
Diversification and Amplification of Yield of Fixed Income Investments
The great bulk of CEFs are invested in bonds, with many of those in tax-free municipal bonds. Other CEFs invest in other instruments, including stocks, corporate bonds and others. Because CEFs usually employ leverage, they are able to produce yields at higher rates than the underlying bonds themselves. Municipal CEFs even offer tax-exempt yields. They accomplish this leverage by borrowing at low short-term interest rates and investing in longer-term bonds at higher rates. This leverage is a two-edged sword, as leverage always is. In the case of the leveraged bond ETFs, when short-term rates rise, the spread between their long-term interest income and their short-term cost of capital can narrow or even turn negative.
Liquidity
Closed-End Funds are definitely not a short-term trading vehicle. Because they don’t trade very widely, their bid-ask spreads vary greatly. About two out of three of the 600 or so CEFs trade under 100,000 shares a day. Their bid-ask spreads can range from just a few pennies per share to several dollars. Trading these latter could consume two or three years’ worth of dividend income, or even more. Speaking of liquidity, the CEFs are the only one of these investment types that are permitted by regulations to buy illiquid assets within the fund – assets that can’t be sold near their NAVs in seven days or less. This permits CEF managers to invest in some things that other managers cannot, for good or ill.
There is a lot more to know about Closed-End Funds. If you are looking for a long-term investment with relatively high yields and regular quarterly (or in some cases monthly) cash distributions, are confident that you will not need to withdraw funds unexpectedly and are not going to be disturbed by high volatility, then they may merit closer attention. If so, perform your due diligence by reading all the neutral information (i.e. not offered by investment advisors or CEF providers) you can find and begin your search.
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