Closed-end funds offer several distinct advantages that help investors meet their investment objectives.
Investment funds provide individual investors with access to professional portfolio managers. This offers investors access to low-cost, extensive investment research, trading and money management expertise that is typically unavailable to them directly.
Stable Asset Base
Because closed-end funds raise a set amount of capital through the fund’s initial public offering (“IPO”), portfolio managers are provided with a stable base of assets from which to invest in securities. A stable asset base allows the fund manager to follow the fund’s investment strategy in accomplishing its stated objective, without having to manage inflows or redemption requests.
Closed-end funds trade on stock exchanges, where investors can buy or sell shares throughout the trading day and at prices that may be above (premium) or below (discount) the fund’s NAV. Investors can also utilize any of the usual stock trading methods, including market/limit orders, stops, short sales and margin trading.
Trading Liquidity and Flexibility
Investors can buy or sell closed-end fund shares in real-time during the trading day at prevailing market prices. This flexibility gives investors the ability to make investment decisions using real-time information.
Investment funds distribute earnings to shareholders at regular intervals – typically monthly or quarterly – in two ways:
- Income is passed through to shareholders as the fund collects net interest or dividends.
- Capital gains, once realized, are passed through to shareholders.
Closed-end funds can use leverage (borrowing funds for additional investments) to amplify investment performance by producing outsized gains or enhancing earnings. Funds can use leverage in two ways: borrow capital or issue preferred shares. If borrowing costs are lower than the net long-term interest rates earned by the portfolio and the markets are rising, then fund shareholders will see greater returns than they would had the fund not used leverage.
When funds use leverage, the NAV will be more volatile than funds that do not use leverage. If borrowing costs increase (making leverage less attractive) or the markets decline, fund returns may suffer as a result of the increased volatility.
Lower Expense Ratios
With a fixed number of shares, closed-end funds do not have ongoing costs associated with distributing, issuing and redeeming shares as do open-end funds. This often leads to closed-end funds having lower expense ratios than other funds with similar investment strategies. Over time, lower expense ratios tend to result in lower fees.
Automatic Dividend Reinvestment Plans
Closed-end fund investors can opt to have any dividends distributions automatically reinvested in additional fund shares. By doing so, shareholders can add to fund holdings without incurring trading costs, as would happen with additional purchases completed in the open market.