Opportunity to Buy at a Discount
When closed-end funds can be bought at a discount to net asset value, investors are buying a dollar's worth of assets for less than a dollar. This can be attractive for two reasons:
- In income-oriented funds, the yield will be higher when calculated on actual dollars invested at a discount, compared to NAV. To take an example, suppose a fund has a NAV of $20 per share, market price of $18 a share, and generates income of $1 per year. The yield based on NAV is 5% ($1 divided by $20). If you bought a mutual fund at NAV, this is the yield you would receive. But in the closed-end fund, the yield based on actual dollars invested is 5.6% ($1 divided by $18).
- If during the holding period of your closed-end fund shares the discount narrows, the reduction in the discount gives a small boost to the fund's performance when you sell the shares. Using the same example in the paragraph above, suppose you bought the closed-end fund at a $2 discount to NAV. Several years later, you sell it at a $1 discount to NAV. Your capital gain would be the change in NAV over this period plus the $1 reduction in your discount.
Efficient Portfolio Management
Unlike mutual fund managers who must worry about constant inflows and outflows of cash, closed-end fund managers are responsible for a stable pool of capital. Although fund shares trade actively, that doesn't affect the fund manager because no assets are flowing into or out of the portfolio. Therefore, closed-end fund managers can put capital to work in a long-term strategy, without worrying whether their fund will have enough liquidity to pay back investors who suddenly sell (redeem) shares. This can lead to superior investment results. It also makes the closed-end fund structure advantageous for investing in specialized areas such as less liquid securities or markets, venture capital opportunities, real estate, and private placements. Regardless of the trading volume or market price fluctuations in such areas, closed-end fund managers are never forced to sell securities in a declining market to meet redemptions. Conversely, in a bull market, closed-end fund managers aren't inundated with new cash they must invest at rising prices.
Ability to Control Market Price and Timing
Closed-end fund orders can be placed throughout the trading day, and limit prices can be specified. This is not possible in a mutual fund because all orders are placed at the close of business, based on the closing net asset value (plus any commissions that apply).
Integration With Brokerage Account
Closed-end funds are bought through brokerage accounts and can be integrated with other services provided by the account and servicing broker, such as margin, consolidated statements, a broker's guidance, and "sweeps" of idle cash.
Leverage Potential
Closed-end funds may issue senior securities (preferred stock or debentures) or borrow money to "leverage" their investment positions. This gives portfolio managers of closed-end funds in the fixed-income area in particular the opportunity to enhance yield and provide investors with superior performance. It also gives them more flexibility to take advantage of timely market opportunities. The use of leverage, of course, increases the likelihood of share price volatility and market risk. (Some closed-end funds do not leverage their portfolios by policy because they wish to avoid the increased level of risk for investors.)
Clear Commissions
You pay one commission to buy closed-end fund shares and another to sell them--and those are the only transaction-related costs. Closed-end funds generally do not impose 'trail commissions' or 12b-1 fees which are assessed against the account annually, as many mutual funds do.
Lower Expense Ratios
Closed-end funds do not incur ongoing costs associated with distributing their shares as do many mutual funds; thus, the expense ratios of closed-end funds are sometimes less than those of mutual funds. Over time, a lower expense ratio provides a boost to investment performance.
No Minimums
Closed-end funds do not impose amounts on purchases or sales, as most mutual funds do.
While many closed-end fund investors also invest in mutual funds, they work with their broker or financial advisor to seek out the best solution to achieve specific goals. Mutual funds fit the need in some cases, and in other cases closed-end funds can do the job as well or better.