Closed-end Fund - Comparison With Open-ended Funds

Comparison With Open-ended Funds

With open-end funds, the value is precisely equal to the NAV. So investing $1000 into the fund means buying shares that lay claim to $1000 worth of underlying assets (apart from sales charges and the fund's investment costs). But buying a closed-end fund trading at a premium might mean buying $900 worth of assets for $1000.

Some advantages of closed-end funds over their open-ended cousins are financial. CEFs do not have to deal with the expense of creating and redeeming shares, they tend to keep less cash in their portfolio, and they need not worry about market fluctuations to maintain their "performance record". So if a stock drops irrationally, the closed-end fund may snap up a bargain, while open-ended funds might sell too early.

Also, if there is a market panic, investors may sell en masse. Faced with a wave of sell orders and needing to raise money for redemptions, the manager of an open-ended fund may be forced to sell stocks he would rather keep, and keep stocks he would rather sell, because of liquidity concerns (selling too much of any one stock causes the price to drop disproportionately). Thus it may become overweight in the shares of lower perceived quality or underperforming companies for which there is little demand. But an investor pulling out of a closed-end fund must sell it on the market to another buyer, so the manager need not sell any of the underlying stock. The CEF's price will likely drop more than the market does (severely punishing those who sell during the panic), but it is more likely to make a recovery when the intrinsically sound stocks rebound.

Because a closed-end fund is listed on the market, it must obey certain rules, such as filing reports with the listing authority and holding annual stockholder meetings. Thus stockholders can more easily find out about their fund and engage in shareholder activism, such as protest against poor management.