Entity Types

Closed End Fund


Closed End Funds are mutual funds that have a fixed number of shares and trade on the New York Stock Exchange

Key Characteristics of Closed Ends Funds
  • Are a type of mutual fund
  • Trade on the NYSE
  • Have a fixed number of shares
    • Shares are not created or redeemed after the fund is created
    • Means that shares can trade at a premium or discount to nav
    • Funds hold an IPO to issue the initial shares
  • Shares are not created or destroyed to meet investor demand - they can only be traded between investors
  • Often will employ leverage (invest long-term and borrow short term)
    • The fixed share count of the funds enables this - there is no risk of investors withdrawing funds
    • Typically leverage ratios are .6 to .7 times equity
    • Use both debt and preferred shares to gain leverage
  • Often are setup for yield and dividend purposes (not capital gains)
  • Can be confused with but are different than ETFs

Benefits of Closed End Funds
  • They offer a liquid way to access illiquid sectors (bonds, preferred stocks, bank loans, etc)
    • Owning these in mutual funds or ETFs could be risky if investors panic and sell at a loss
  • Offer access to cheap leverage (big funds get better interest rates)
  • Offer tax advantages
  • When trading at a discount, they offer a unique value
  • Offer way to turn boring investments into large gains
    • Earn the normal yield the underlying assets pay
    • Get price appreciation in underlying assets
    • Get price appreciation when discount to Nav shrinks
  • 3 Ways to Make Money
  1. Collect dividend payments (boosted by leverage)
  2. Capture capital gains if the underlying assets appreciate
  3. Benefit from a shrinking discount to NAV (if you purchase at a discount)

Premiums and Discounts to NAV
  • Trade at a premiums or discounts to NAV (depending on investor demand)
    • Sometimes the premium or discount can be >10% of Nav.¬† This creates significant buying or selling opportunities
    • The leverage employed amplifies price swings
  • Became popular and sold at premiums in the 2010s when interest rates were stuck around zero and investors sought yield
  • Prices tend to fall and tradet discounts when rates are increasing
  • CEFs can be prone to trading at discounts¬†
    • CEFs are often small & thinly traded - which can lead to price swings
    • CEFs are primarily traded by retail investors (often unsophisticated) who may sell based on fear or without realizing they are selling at a discount
    • can be a good time add to them - buying at a discount is a great opporunity

Optimal Conditions for Closed End Fund Performance

Municipal Bond Fund Closed End Funds

  • Started to trade at large 10-15% discounts as rates rose in 2017 and 2018
  • Investors shied away from rising rates
    • Rising rates lower asset values of bonds held in the fund
    • Rising rates increase interest expense on fund leverage