Are Closed-End Funds Getting Hot Again?

Long before the rise of exchange-traded funds, closed-end funds were mutual funds that traded on exchanges alongside stocks. In fact, CEFs date back all the way to the late 19th century.

CEFs are similar to ETFs in many ways, but there are several key differences.

What's A Closed-End Fund?

CEFs are mutual funds created and launched on a public exchange in a process similar to an IPO. The CEF raises a fixed amount of money for the fund manager, which then takes the proceeds from the sale and invests them according to the fund’s mandate. Shares then trade on the open market just like a stock or ETF. However, unlike open-end funds, the total shares of a CEF are fixed and the fund managers do not create new shares as they take in more money.

One of the primary appeals of CEFs is that they typically provide a steady monthly or quarterly income stream for fixed-income investors compared to the biannual payouts associated with individual bonds. CEFs can be seen as a defensive play in a rich and unpredictable market.

NAV, Fees Are Key

Two key metrics for CEF investors to know are expense ratios and net asset value.

CEFs typically have relatively high expense ratios, or the annual fees charged by fund managers. The average ETF carries an expense ratio of 0.44 percent, according to the Wall Street Journal.

The five largest CEFs in Morningstar’s database all have expense ratios of at least 2.2 percent. These fees eat into investor returns each year, and the impact is compounded the longer the fund is held.

In addition to expense ratios, CEF investors need to understand net asset value. NAV is the total market value of all the assets held in the fund. In theory, the NAV per fund share would always be at or near 1, since the total value of the fund should be in-line with the value of its holdings.

In practice, share prices of CEFs are often not in-line with per-share NAV. Fund shares are often priced much higher than the value of their holdings. In other words, investors are paying a market premium to own these funds, and it would be cheaper to buy the underlying assets individually.

There’s nothing inherently wrong or dangerous about a CEF trading a premium or a discount to its NAV, but investors should fully understand what it means.

Popular CEFs

For investors willing to take the plunge and consider buying some popular CEFs, the following are the five CEFs with the highest daily trading volume, according to Morningstar:

• Liberty All-Star Equity Fund USA
• Aberdeen Asia-Pacific Income Fund, Inc. FAX
• Eaton Vance Tax-Managed Global Dive Eq EXG
• PIMCO High Income Fund PHK
• Nuveen Preferred & Income Securities Fnd JPS

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