Definition
A Closed-Ended Mutual Fund is a type of investment fund with a fixed number of shares that are only issued initially during an Initial Public Offering (IPO). Unlike open-ended funds, new shares in a closed-end fund are not created by managers to meet demand from investors. Instead, the shares can be purchased and sold only in the market from existing shareholders, similar to stocks.
Key Takeaways
- Closed-end mutual funds issue a fixed number of shares which are traded among investors on an exchange, similar to stocks. Unlike open-end funds, these funds do not issue new shares beyond the initial public offering, thus they are “closed” to new investments.
- The share price of a closed-end fund is determined by market demand, not by net asset value (NAV). Therefore, the shares of such funds may trade at a premium or discount to their NAV, depending on supply and demand factors in the market.
- Unlike open-end mutual funds, closed-end funds can use borrowing and other forms of leverage to enhance their returns. However, this can also potentially increase their risk, and thus should be taken into consideration by investors.
Importance
Closed-ended mutual funds are significant in finance due to their unique structure and trading flexibility.
Unlike open-ended funds that continuously issue and redeem units based on demand, closed-ended mutual funds have a fixed number of shares which are traded on the stock exchange.
This allows investors to buy and sell shares at any point during the trading hours, offering more liquidity.
Moreover, these funds are not obliged to redeem shares at any time, providing fund managers with more stability to make long-term investment strategies without the concern of unexpected redemptions.
This can potentially lead to higher returns, making closed-ended mutual funds an essential financial instrument for both fund managers and investors.
Explanation
Closed-Ended Mutual Funds are primarily used to generate a steady stream of income for investors while also helping to diversify their portfolio. These funds have a fixed number of shares and are collectively managed for the purpose of investing in a portfolio of different securities such as stocks, bonds, or other types of assets to meet specific investment objectives.
These objectives often vary from fund to fund and could focus on generating income, capital appreciation, or both. As with any investment tool, the purpose of investing in a closed-ended mutual fund is to earn returns.
However, these funds may offer a special appeal to investors looking for regular income, as many tend to pay out dividends more frequently than their open-ended counterparts. In addition, these funds are oftentimes used by investors to delve into more illiquid or niche sectors, such as emerging markets or the real estate sector, which might be difficult for an individual investor to access by other means.
Due to the fixed supply of shares, fund managers are not forced to buy or sell securities at inopportune times in order to meet redemption requests, allowing for a potentially more strategic and long-term focused portfolio management. Thus, one of the main factors making closed-ended mutual funds attractive is their ability to take a more long term, potentially risky, yet rewarding approach to investing.
Examples of Closed Ended Mutual Fund
Fidelity and Guaranty Life: Fidelity and Guaranty Life (FGL) is a closed-end fund that invests in a diversified portfolio of stocks and bonds. The goal of FGL is to provide long-term capital growth to its investors. This fund is no longer open to new investors; however, shares of the fund can be bought and sold on the secondary market.
SBI Magnum: SBI Magnum is a closed-end mutual fund sponsored by the State Bank of India. The fund offers fixed income products and is designed to generate regular income and capital appreciation for its investors. After the initial subscription period, shares of SBI Magnum can only be traded on the secondary market.
BNY Mellon Strategic Municipal Bond Fund: This is a closed-end investment fund that aims to provide a high level of current income exempt from federal income tax. The portfolio managers seek to achieve this by investing in a diversified portfolio of investment grade municipal bonds. After the initial offering, shares are bought and sold on the New York Stock Exchange.
FAQs About Closed Ended Mutual Funds
What is a Closed Ended Mutual Fund?
A closed ended mutual fund is a type of mutual fund that has a set number of shares issued to the public through an initial public offering. Unlike open-end mutual funds, closed-end funds do not continually issue and redeem shares.
How do Closed Ended Mutual Funds work?
Closed-ended funds issue a fixed number of shares and these shares are traded on the open market. The price of the shares fluctuates based on supply and demand, as well as the changing value of the assets within the fund.
What is the difference between Closed Ended and Open Ended Mutual Funds?
The key difference between closed ended and open ended mutual funds is that closed ended funds do not issue and redeem shares on a regular basis. This means the number of shares in a closed ended fund is fixed, whereas with open ended funds, the number of shares can vary depending on investor demand.
What are the advantages of Closed Ended Mutual Funds?
Closed end funds can invest in a broader range of securities, including less liquid securities because they do not have to worry about daily liquidity demands. Closed end funds also tend to have lower ongoing expenses compared to open-ended funds because they aren’t continually creating and redeeming shares.
What are the disadvantages of Closed Ended Mutual Funds?
Because closed end funds are traded on an exchange, they can trade at a discount or premium to their net asset value. If the shares trade at a discount, it means that you are buying the fund’s assets for less than their actual value. However, if the shares trade at a premium, it means you are paying more than the actual value of the assets.
Related Entrepreneurship Terms
- Net Asset Value (NAV)
- Capital Gains
- Public Offering Price (POP)
- Fund Manager
- Portfolio Diversification
Sources for More Information
- Investopedia – This is a reputable source for finance and investing concepts. They provide easy-to-understand definitions and examples.
- Morningstar – A renowned investment research firm that covers a wide range of investment products, including closed-ended mutual funds.
- BlackRock – BlackRock is a global investment manager. They cover a wide variety of financial topics, including closed-ended funds.
- The Motley Fool – Provides investing insights and stock recommendations for investors of all skill levels.
