By Lee McGowan. Mutual Funds Expert
Despite the similarities of closed-end funds (CEFs) and mutual funds. they are two distinct types of investment companies. If you have read “ What Is a Closed-End Fund? ” and learned about the basics of the fund structure, then take a closer look at CEFs below.
Buying and Selling CEFs
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The cost of the transaction for a CEF is similar to the cost of a stock trade. There are also internal management fees paid to the fund company to manage the fund.
Another cost to be aware of for a CEF is the bid-ask spread. If you place an order to buy a CEF and, at the same time, place an order to sell the fund, the prices for both would be different. In other words, your cost to buy the CEF and the price you would get for selling the CEF would be different. For instance, you might sell at the bid price of $9.90, while you would buy at the ask price of $10.
This $.10 difference is known as the bid-ask spread and is considered the cost of doing business on the exchange or over the counter.
You can buy both CEFs and mutual funds through a broker. The broker processes the transaction on the stock exchange in the case of CEF, or with the fund company in the case of mutual funds.
Net Asset Value vs. Price of CEFs
It is easy to confuse the net asset value (NAV) of the CEF with the fund’s price. To avoid confusion, you can simply think of the NAV as the value of the CEF’s holdings (stocks, bonds, cash, etc.) minus any liabilities, divided by the total number of fund shares that are held by investors.
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Therefore, unlike a mutual fund, the NAV of a CEF is not the price you pay for a share of the fund.
CEF s are often bought or sold at a discount to their NAV. In other words, if a CEF owns 100 stocks that have a combined value of $1,000,000 with
$0 liabilities and 100,000 shares outstanding, the fund has an NAV of $10. Investors might not value the portfolio manager’s ability to pick stocks, however, so they might only be willing to pay $9 per share of the fund. So, this fund would be trading at a discount of 10% to its NAV.
Why Do Fund Companies Choose the CEF Structure?
There are many reasons a fund company might decide to structure their fund as a CEF rather than an open-end mutual fund (and vice-versa). It could be that the fund company has a particular niche that is better served through CEFs. For example, if a fund company wants to manage a fund that holds securities that are not easy to trade (illiquid. such as stock of a very small company that is rarely traded on the stock exchange), then they might form a CEF.
Another reason to form a CEF, which will also help clarify the previous reason, is because the fund managers of CEF s are not forced to sell a particular security when an investor wants to sell his/her shares of the fund. For example, let’s say we have a manager who is running two funds that differ only in structure -- one is a CEF, while the other is an open-end mutual fund. The funds both hold Wal-Mart and Target shares. The fund manager loves both stocks.
If an investor wants to sell his/her shares of the CEF, then there is no problem; the fund manager is able to continue to hold both stocks because the investor goes to an exchange to sell his/her shares to another investor. On the other hand, because investors in a mutual fund go to the fund company to redeem his/her shares, the fund manager must sell either Wal-Mart or Target shares in order to meet redemption needs and raise cash for the investor.
How Do I Find Out More About CEFs?
For investors who want to try their hand at CEFs, there are numerous options. One great place to start is at Nuveen Investments’ website, which provides a wealth of information about more than 650 CEFs.