What is the downside to closed-end funds?
Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee a fund's investment objective will be achieved. Closed-end fund shares may frequently trade at a discount or premium to their net asset value (NAV).
Cons of closed-end funds
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.
The drawbacks of closed-end credit include, but are not limited to: You only have access to the funds agreed upon between you and your lender — these funds don't replenish as you pay them back. Closed-end credit agreements come with fixed monthly payments.
Equity Securities Risk: Closed-end funds that invest in common stock and other equity securities are subject to market risk. Those equity securities can and will fluctuate in value for many different reasons.
Closed-end funds operate more like ETFs, in that they trade throughout the day on a stock exchange. Closed-end funds have the ability to use leverage, which can lead to greater risk but also greater rewards.
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
Closed-end funds that return capital can carry a higher level of risk because the fund is eroding the asset base available to generate income to pay distributions. Some closed-end funds set a specific distribution rate to pay regardless of the income generated by the fund.
Because of their closed-end structure, CEFs are allowed by law to use leverage. Specifically, according to the Investment Company Act of 1940—which provides the framework for CEFs, mutual funds, and ETFs—CEFs are allowed to issue: Debt in an amount up to 50% of net assets.
Key Takeaways
A line of credit allows you to withdraw the amount you need when you need it instead of receiving a lump sum. Closed-end lines of credit have an end date for repayment. Open-end lines of credit usually have no end date for repayment, or a very long term for revolving credit.
A closed account can be good or bad for your credit scores, depending on the account's payment history before it was closed. Because a positive payment history stays on your credit report for up to 10 years, even a closed account can help you maintain good credit scores.
What happens when you sell a closed-end fund?
Conversely, closed-end fund shares are bought and sold at "market prices" determined by competitive bidding on exchanges and not at NAV. Let's assume that the market price is $18 per share and that NAV is $20. In this case, the closed-end fund sells at a discount of $2 per share.
A term fund has a specified termination date at which time the fund's portfolio is liquidated. Investors who own shares when the fund terminates receive a cash payment equal to the NAV per share at that time.
“If you are a retiree and you are counting on monthly income, CEFs may fit perfectly in your portfolio,” she says. But Marfatia also cautions that while CEFs provide exposure to a wide variety of asset classes, they often contain leverage, which means additional risk.
Closed-end funds (“CEFs”) can play an important role in a diversified portfolio as they may offer investors the potential for generating capital growth and income through investment performance and distributions.
With a closed-end fund, an investment company sells a fixed number of shares in the fund to investors. Managers of the fund have a relatively fixed amount of capital to invest over time, because investors can't withdraw money from the fund or buy in after the IPO — They can only buy or sell shares on an exchange.
Investors can buy and sell shares throughout the day, and the fund's price on the exchange fluctuates during the day, much like a stock. A closed-end fund's market price can be the same as or higher or lower than its net asset value per share. (We'll dig into this below.)
The advantages of investing in mutual funds are portfolio diversification, lower expenses, high liquidity, professional management, etc., and the disadvantages of investing in mutual funds are costs for professional management, fund manager bias, etc.
Mutual funds have pros and cons like any other investment. One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins.
Disadvantages. There are fees involved when investing in a managed fund, as you are hiring the service of the fund manager to produce returns on your investment. The amount of fees can vary greatly and can have a significant impact on your overall returns.
But Clough Capital research also shows that closed-end discounts widen as interest rates rise and narrow as they fall. That's largely because of the leverage strategies many of these funds employ: lower rates mean lower borrowing costs.
Can closed ended mutual funds lose value?
Typically, market risk results in greater fluctuations in the net asset value (NAV) when the remaining maturity of a portfolio security is longer. Equity Closed-End Funds: The vulnerability of seeing a decline in their NAV and market price is a shared risk among all equity closed-end funds.
Closed-end funds generally issue a fixed number of shares that are listed on a stock exchange or trade in the over-the-counter market. The assets of a closed-end fund are professionally managed in accordance with the fund's investment objectives and policies, and may be invested in stocks, bonds, and other 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.
| No. | Symbol | Market Cap |
|---|---|---|
| 1 | BXSL | 6.10B |
| 2 | PDI | 5.16B |
| 3 | DNP | 3.21B |
| 4 | NEA | 3.19B |
Some closed-end funds hold low-quality securities as another way to boost their distributions. If they own low-quality stocks and bonds, the funds can be more volatile and carry additional risk. As a result, the funds themselves can be difficult to sell and are subject to increased price fluctuations.
