Closed-End Funds

An Introduction

Closed-end funds (CEFs) are a type of investment company. The shares are typically listed on a stock exchange, such as the New York Stock Exchange. They are listed on exchanges in many countries, such as the United States, Canada and the United Kingdom. A CEF has an investment mandate and is professionally managed according to this mandate. For example, a CEF might invest in municipal bonds, taxable bonds, preferred stock, equity or other asset classes.

Unlike other kinds of investment companies, such as mutual funds and exchange traded funds (ETFs), the price of a CEF can diverge significantly from the market value of the underlying investments, called the net asset value (NAV). This is because the share price is governed by market supply and demand. There is no straightforward arbitrage to bring the share price and NAV in line, such as share creation and redemption in the case of ETFs. When the price of a CEF is less than the NAV, it is said to be at a discount. Conversely, when the price is greater than the NAV, the CEF is said to be at a premium.

Various statistical methods can be used to judge whether a closed-end fund is trading at an unusual discount or premium. Some CEFs, particularly equity CEFs, are expected to trade at considerable discounts. CEF Analyzer provides tools for this analysis.

Like stocks, CEF shares are issued during an initial public offering (IPO). The CEF shares will be issued at a premium to NAV and will typically, though not always, fall in value over the subsequent months, often to a discount. It is typically wise to wait until this has happened before investing.

For investors, aside from being able to trade CEFs to exploit discounts and premiums that might arise in the secondary market, CEFs have other appeals.

They often have relatively high yields, sometimes through leverage and sometimes by investing in risky or illiquid securities and often both.

Because CEFs do not face redemptions from shareholders, unlike mutual funds, CEFs have the flexibility to invest in illiquid securities, for example, illiquid municipal bonds or private equity.


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