Closed-end and Open-end Funds

In the United States, closed-end funds are known as closed-end companies, being recognized by the Securities and Exchange Commission (SEC) as one of three types of investment companies with legal standing, the other two being unit investment trusts and mutual funds. In the UK closed-end funds are referred to as investment trusts. Closed-end fund share prices are determined by the value of the investments in the fund, together with either the premium or discount placed on it by the market – premium being when the share price is higher than the per share net asset value (NAV), and discount being when it is lower. The NAV is determined by taking the total value of all the securities making up the fund and dividing it by the number of shares in the fund.

Closed-end funds operate on the stock market in much the same way as a publicly listed company does. It will have an initial public offering (IPO) of a set number of shares, raising a predetermined amount to be invested by the fund manager. Once the shares have been sold, they begin trading on a secondary market. Closed-end funds do not generally sell more shares after the IPO, nor do they redeem their own shares, although this is not carved in stone.

As one would expect, there are supporters of both open-end and closed-end funds, with proponents for the latter listing financial advantages such as not having the expense of creating and redeeming shares; not having to be concerned about market fluctuations spoiling their performance record; and not being subject to investor panic which may result in an en masse sell-off and a drop in market price. Investors wishing to pull out of a closed-end fund must sell to another buyer, which doesn’t involve the fund manager and the underlying stock. Another advantage of a closed-end fund for investors is that the fund must obey rules governing the stock market, filing the relevant reports and holding annual stockholder meetings. This gives stockholders easy access to details on their fund’s performance as well as the opportunity to raise any concerns they may have.