posted on 06-06-2019

Closed Fund

Updated October 1, 2019

What is a Closed Fund?

A closed fund, also called a closed-end fund, is a publicly traded security that offers its shareholders partial ownership in an underlying portfolio of assets.

How Does a Closed Fund Work?

Closed funds initially raise capital through an initial public offering. They then use the proceeds to invest in a basket of securities. The term "closed" refers to the fact that once the initial shares are issued, the fund is basically "closed" to new investors wishing to purchase shares from the company. Instead, buying and selling takes place between individual investors.

Investment companies are classified as either closed-end or open-end, depending on the fund's redemption feature. Closed funds do not redeem investors' shares -- shares are bought and sold at market prices on an exchange. Open-end funds, also known as mutual funds, directly buy and sell investor shares at net asset value (NAV). NAV is simply the fund assets minus fund liabilities.

Similar to common stocks, closed funds usually trade on one of the major U.S. exchanges. However, unlike regular stocks, they represent a share of a specialized portfolio managed by a group of investment advisors. These managers typically concentrate on a specific industry, country or sector. Management strategies are explained in a closed fund's prospectus, which should be reviewed thoroughly before investing.

Closed funds typically invest in more speculative investments than open-end mutual funds, and they sometimes invest in illiquid assets or alternative asset classes. For example, Closed Fund XYZ may specialize in buying and selling mortgage-backed securities (MBS). MBS are generally not available to individuals, so if you want exposure to them, you can buy shares of Closed Fund XYZ.

One important aspect of closed funds is that their share price can deviate substantially from their NAV. If the shares are trading at a higher price than the fund's NAV, they are said to be trading at a premium. Conversely, a fund with a share price lower than its NAV is said to be trading at a discount. Closed funds that trade at substantial discounts to their NAV may offer compelling opportunities for investors to pick up good assets on the cheap.

Why Does a Closed Fund Matter?

Closed funds can be an easy way for an individual to invest in a piece of a diversified portfolio. Like open-end funds, these securities allow individual investors an opportunity to invest in a wide range of assets, industries, countries, etc. They also allow the individual investor a chance to invest in highly specialized and sometimes speculative instruments that would otherwise be off-limits or unavailable.

Before purchasing, it is important to understand any sales fees and management expenses, which are listed and explained in the fund's prospectus. Fees vary and can eat away at your total return.