A closed-end fund, legally known as a closed-end investment company, is one of three basic types of investment companies The two other types of investment companies are open-end funds (usually mutual funds) and unit investments trusts (UITs). Exchange-traded funds (ETFs) are generally also structured as open-end funds, but can be structured as UITs as well.
A closed-end fund invests the money raised in its initial public offering in stocks, bonds, money market instruments and/or other securities.
Here are some of the traditional and distinguishing characteristics of closed-end funds:
- A closed-end fund generally does not continuously offer its shares for sale but instead sells a fixed number of shares at one time. After its initial public offering, the fund typically trades on a market, such as the New York Stock Exchange or the NASDAQ Stock Market.
- The price of closed-end fund shares that trade on a secondary market after their initial public offering is determined by the market and may be greater or less than the shares’ net asset value (NAV). Shares that sell at a price higher than the NAV are said to be sold at a premium, and shares that sell at a price lower than the NAV are said to be sold at a discount.
- A closed-end fund generally is not required to buy its shares back from investors upon request. That is, closed-end fund shares generally are not redeemable. In addition, they are allowed to hold a greater percentage of illiquid securities in their investment portfolios than mutual funds are. An "illiquid" security generally is considered to be a security that cannot be sold within seven days at the approximate price used by the fund in determining NAV.
- Closed-end funds are registered with the SEC and subject to SEC regulation. In addition, the investment portfolios of closed-end funds typically are managed by separate entities know as investment advisers that are also registered with the SEC.
- Closed-end funds typically pay distributions on a monthly or quarterly basis. These distributions can include income generated by the fund – interest income, dividends, or capital gains – or a return of principal/capital. A return of principal/capital reduces the size of the fund’s assets. Closed-end funds are required to send a written notice - called a 19(a) notice - whenever distributions include a return of capital.
There are many varieties of closed-end funds. Each may have different investment objectives, strategies, and investment portfolios. They also can be subject to different risks, volatility, and fees and expenses. Fees reduce returns on fund investments and are an important factor that investors should consider when buying shares.
You should carefully read all of a fund’s available information, including its prospectus and most recent shareholder report before purchasing fund shares.