Updated July 17, 2023
Definition of Closed-End Fund
A closed-end fund is professionally managed by the fund managers and fundraises a fixed amount of capital through an initial public offering (IPO), after which the fund lists the shares on a recognized stock exchange.
The total number of shares or units remains the same since a closed-ended fund allows the investors to subscribe to its units or shares only for a limited period until the IPO is over. The only way investors can exit is by transacting the units or shares on the secondary market (i.e., recognized stock exchange) before the redemption date.
Explanation
Closed-end funds are funds having a fund manager make decisions regarding the buying and selling of assets according to the condition of the market. The main feature of closed-ended funds is that it allows investors to subscribe to their units only for a limited period until the IPO is over, after which the units are listed for trading on the recognized stock exchange. These funds usually have a maturity period of 3 to 5 years, after which the fund redeems the units to its investors. The prices of such funds are kept on fluctuating based on the factors of demand and supply. Once the units are listed on the stock exchange, the only exit option the investors have is to sell the units on the stock exchange if the investor wants to exit the fund before its redemption.
How Does it Work?
Professional fund managers manage closed-end funds, and such managers make the decisions with respect to investments. In return for their professional services, the managers in closed-end funds are charged some fees, known as management fees. The closed-end funds are inaugurated only through an Initial public offering (IPO) for a short period (2-10 days). The investors can subscribe to the fund units during this period. Once the period is over, the subscription is closed, and no more applications are accepted. The subscribed units are then floated on recognized stock exchanges, such as NYSE.
Investors can buy and sell units on the stock exchange. The price of the funds can vary depending upon the market forces of demand and supply. Closed-end funds generally offer higher returns or better-earning streams when compared with open-end funds. The redemption period for such funds is from 3 to 5 years on average.
Examples of Closed-End fund
- Municipal Bond Funds: This fund is the most significant type of closed-end fund. Managers of such funds seek to get maximized returns. These funds invest in debt obligations of the local government, state government, and government agencies.
- Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG): This is one of the largest closed-end funds founded in 2007, having a market capitalization of US$2.23 billion as of March 2020. The main motive of such funds is to provide income and gains.
- Witan Investment Trust Plc: This investment trust is an excellent example of a closed-end fund established in 1909 to manage the estate of Alexander Henderson, 1st Baron Farringdon.
- Scottish Mortgage Investment Trust: The Scottish mortgage investment trust is an example of a closed-end fund it is founded in the year 1909. This investment trust’s headquarters are in Edinburgh, Scotland, United Kingdom. It invests globally in strong businesses with average returns.
- Cohen & Steers Quality Income Realty Fund (RQI): This fund has $1.6 billion in assets and a NAV of around $14.75. The fund has earned an annualized 10-year return of 19.2% as of the end of 2019, which makes it among the top-performer closed-end fund over the past decade.
Advantages of Closed-End Funds
Some of the advantages are given below:
- Investment in other financial assets: Investors get the benefit of diversification of their funds since the closed-end fund investors further in different asset classes.
- Helpful in taking a logical decision: The money of investors in safe and locked until the maturity date which provides more time to take a logical decision by the manager.
- Transparent pricing: It has a simplified pricing policy. The price of a closed-end fund fluctuates as per the supply and demand, as well as the dynamic values of its portfolio’s holdings.
Disadvantages of Closed-End Fund
Some of the disadvantages are given below:
- High fees of fund managers: The involvement of fund managers increases the operational cost of the fund and thereby reduces the returns of the investors.
- Involvement of intermediaries: The closed-end funds can be purchased only through the brokers or intermediaries which increases its actual cost by way of commission due to the involvement of the middlemen between the investors and the funds.
- Limited time for entry: In closed-end funds, the entry into the funds is limited since the investors can only enter until the initial subscription is open.
- Less liquidity: The investors have less liquidity in these funds as the units can only be sold on the stock exchange and are not presented for redemption until the maturity of the units.
Conclusion
Thus by the above study, we can conclude that the closed-end fund proves to be very useful. It can be defined as professionally managed funds having a defined portfolio the capital of which is raised through an initial public offering (IPO) and it can only be traded in the secondary market. The closed-end funds provide the facilities of investment in other funds, flexibility, and more profit and it is also helpful in making logical decisions. It has some cons like high fees, rapid changes, and involvement of intermediaries but if we compare the pros and cons of closed-end funds we can find its advantages outshining its disadvantages.
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