What Is Closed Ended Fund?

The closed ended mutual fund, actively managed by an investment management company or fund manager, acts as a publicly listed investment firm or security. It trades at a premium or discount to net asset valueNet Asset ValueNet Asset Value (NAV) refers to the net value of an entity or equity obtained by subtracting the total value of its assets from the total value of its liabilities. It also indicates the per share or unit market value of securities like mutual funds, exchange-traded funds (ETFs), indexes, etc., on a given day.read more per share on stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more, and its price fluctuates according to supply and demand. Examples of it include municipal bondMunicipal BondA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports.read more funds and global investment funds.

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Key Takeaways

  • Closed ended mutual fund meaning refers to an investment structure that raises capital by issuing a defined number of shares in the open market for a certain period through an IPO. It cannot issue new shares, and investors cannot redeem or repurchase their shares until the fund matures. A closed ended fund is publicly traded on a stock market at a premium or discount to NAV per share, is registered with a securities commission, and is actively managed by an investment management firm or a fund manager. Investors can buy or sell closed end fund shares from traditional or online brokers in the secondary market for a fee. However, its price fluctuates during the trading day due to variations in supply and demand and the fund value.

Understanding Closed Ended Fund

A closed ended fund lists on the stock exchange and issues a limited number of shares through an IPO to raise capital. It has a maturity date, which means it is only issued once, and no more shares are issued, or exiting shares are bought back or redeemed until that day. Investors can buy or sell shares in the secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.read more, depending on the supply and demand. The fund is “closed to new investors” once all of the shares have been sold.

A money manager or investment management firm typically controls the closed ended fund. The fund pools investor capital through an IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more to invest in a basket of securities, such as stocks, bonds, etc., speculative investments, illiquid assets, preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more, alternative asset classes, or debts. In exchange, investors receive shares at the net asset value (NAV) per share valid for that day equivalent to their initial investment. Furthermore, they manage investor portfoliosManage Investor PortfoliosPortfolio management involves overseeing a set of investments, including securities, bonds, exchange-traded funds, mutual funds, cryptocurrencies, etc., on a personal or professional levelread more and make decisions regarding buying, selling, and holding shares.

Features Of Closed Ended Fund

  • The fund house or company must be registered with a securities commission, such as the United States Securities and Exchange Commission.Investors must have a brokerage accountBrokerage AccountA brokerage account is a taxable investment account in a brokerage company where a person deposits its assets and instructs the company to trade in shares or bonds on their behalf. In addition, the company deducts some brokerage or commission.read more and can buy or sell shares from traditional or online brokers for a fee.Shareholders receive partial ownership in the underlying securities and a portion of the income and capital gainsCapital GainsCapital gain refers to the profit resulting from selling a capital asset or investment at a price higher than its purchase price.read more generated by the fund.The fund gets closed for subscription or sale before the investment matures, and hence no money flowsMoney FlowsMoney flow (MF) refers to a mathematical function used to analyze changes in the value of a security by multiplying its typical price by daily trading volume.read more in or out of it till then.It trades on the open market with its price fluctuating all the trading day due to changes in the supply and demand and the fund value.The fund offers less liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more, so retail investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making.read more should opt for it carefully.Using a heuristicsHeuristicsHeuristics refers to a problem-solving and decision-making approach where individuals or entities consider past results or experiences and the minimal relevant details to reach a practical conclusion.read more method for investments could be risky due to closed ended funds’ uncertain track records.

Open Ended Fund vs Closed Ended Fund

When comparing open ended and closed ended mutual funds, the former offers more flexibility regarding the amount to be invested, investment tenure, and expected returnsExpected ReturnsThe Expected Return formula is determined by applying all the Investments portfolio weights with their respective returns and doing the total of results. Expected return = (p1 * r1) + (p2 * r2) + ………… + (pn * rn), where, pi = Probability of each return and ri = Rate of return with probability. read more. On the other hand, the latter only permits yields to be withdrawn once the investment has reached maturity. Furthermore, unlike an open ended fund, the closed ended fund shares are fixed, i.e., investors can only sell a certain number of shares.

Examples

Let us consider the following closed ended mutual fund examples to understand the concept well:

Example #1

Martha invested $1,000 in a closed ended fund for three years. She was sure she would not need any amount in between to serve any purpose. However, she suffered a medical emergency within a year of investing and hence tried to withdraw her holdings as required.

Unfortunately, the money manager informed her that she could not redeem her investment before the completion of three years. As a result, Martha had to apply for other loan options to deal with her then-medical expenses.

Example #2

The closed-ended investment companies Cornerstone Strategic Value Fund and Cornerstone Total Return Fund announced that they would maintain their 2021 distribution policy for 2022. Accordingly, the dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more percentage for the calendar year 2022 will stay at 21%, and it will be applied to the NAV of each fund as of the end of October 2021.

Pros and Cons

Investing in a closed-end mutual fund provides investors with a reliable source of income. As a result, they can plan significant expenditures based on the expected return on investment.

While there are numerous advantages to investing in such mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more schemes, investors should know the drawbacks before doing so:

This has been a guide to Closed Ended Mutual Fund and its meaning. Here we discuss features of closed ended mutual fund, along with examples, pros, and cons. You can learn more from the following articles –

Closed ended fund pools investor capital through an IPO to invest in speculative investments, illiquid assets, preferred shares, alternative asset classes, or debts. It issues a set number of shares for a defined length of time, until which the holdings cannot be redeemed or repurchased. Shares trade on stock exchanges at a premium or discount to NAV per share. Due to supply and demand fluctuations, the fund price fluctuates throughout the trading day, and the fund value changes.

Closed ended funds may not be as flexible as open ended mutual funds, but they are the better option for investors looking for higher returns. While an open ended fund is more flexible in terms of the amount to be invested, the duration of the investment, and expected returns, a closed ended fund only allows the dividend to be withdrawn once the investment has matured.

Investors can close a closed ended mutual fund by selling the fund’s shares on an open market, such as a stock exchange.

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