Type of Investment : Closed End Funds. Should you invest in it?
There are many investment types out there in the market. One of the popular ones is closed end funds. If you have invested in mutual funds before then you have actually invested in closed end funds. If an investor told you about having invested in ‘mutual funds’, he is actually telling you that he has invested in this type of investment.
These mutual funds are all having some kind of similarities with each other but they also have other obvious differences as well. Understanding and reading about closed-end funds will assist you greatly in giving you more useful information so that you could make a better judgment of whether you should include this type of investment in your portfolio.
It also pays to read more about closed-end funds so that you are able to maximize your return of investment in the long run and at the same time minimize your risks of losing money.
The following are some basic principles in understanding what open-end funds and closed-end funds actually are and the difference between the two.
After initial IPO, when subscription is closed, no additional new subscription is allowed. During the period of trading, some funds may either produce profits or experience losses. So in the event of loss, the company would naturally lose all the capital that was initially invested. But all these would be generally compensated when the company receives other new investors.
Closed-end mutual funds on the other hand are just the opposite. After the initial IPO and the funds began their maiden trading, they essentially already have whatever capital they need from the investors. Should more capital is required; they usually exercise other options but usually not by issuing more shares. We will get more into this later.
Closed-end shares trading on stock exchanges have similarities with trading of stocks in the stock market. The shares or stocks are offered to the public during the initial IPO. Thereafter, if any investors wish to purchase more shares, they would have to go through a secondary market. It simply means they have to buy their shares from other investors. In terms of pricing, the open-end mutual funds buying prices are usually set when the trading day has ended or the price at the closing of trading day, whereas prices for closed-end fund are available throughout the day.
Unlike the pricing of open-end funds which are usually set according to its NAV (the net asset value) the closed-end funds are sold at a discount or premium and not its Net Asset Value. Net Asset Value is calculated by minusing any debt that the fund may have from the total overall fund’ value holdings and whatever cash on hand available; divided by numbers of issued shares so far.
As mentioned earlier, the pricing of closed-end funds are not based upon their NAV, but instead determined by current market situation or environment and the price other investor are willing to trade in the stock exchange. As a result of this, closed-end funds are almost usually priced at a discount in relation to the underlying assets’ current value.
Securities that are not listed can be actually be utilized by the company who managed closed-end funds. Unlisted securities are basically stocks or shares on the stock exchange that are not listed due to various reasons. One of the reason shares are not listed may be due to certain requirements set by the stock exchange are not met or perhaps it is done voluntarily because the company do not want to abide by the rules and restrictions imposed by the stock exchange if they were to be listed. Having said that a closed-end mutual fund maybe of higher risk due to the fact that it can utilize unlisted securities. But by being riskier also mean the possibility of getting higher or profitable returns very likely. As long as such risks are calculated ones, there is no reason why investors should shy away from investing in this type of investment.
Open-end funds, on the other hand are more conservative in nature. However, being conservation does not mean that it is risk free. In fact, both types of investments carry within them certain risks albeit calculated risks.
Closed-end funds can also use the power of ‘leveraging’ for the sole purpose of increasing the chances of greater investment return. In other words, the company can opt to issue other stock and/or bonds, and exercise other options in order to raise help raise extra capital for investment. So if closed-end mutual funds wish to increase their rate of investment returns, they are allowed to borrow and that is what ‘leveraging’ means. On the other hand, an open end mutual fund would issue more shares to sell should they want to do obtain the same result.
The obvious benefit of closed-end funds is that you can invest with peace of mind. They have a full team of professionals to manage the funds for you. Apart from the benefit of having a team of professionals, potential investors also pay significantly lower expense compared to the typical open-end mutual fund. Expenses for marketing and sales are negligible or almost non-existent in open-end funds because they don’t have any product to sell. Therefore, closed-end mutual funds’ management fees are comparatively lower. The fund managers are also flexible with less restriction imposed on them in managing open-end mutual funds. Although, the risk may be higher as such but theoretically, opportunities to reap greater returns are significantly higher as well. Based on the above discussion, you may conclude that features in this type of mutual funds investment and that is the closed-end mutual funds actually a combination of both stock and open-end mutual funds.
It is actually interesting to learn more about these two types of mutual funds investing and you need to seek more information before you decide to invest.
Hopefully the information discussed earlier has given you more or less some basic overall ideas of what mutual funds investing are all about. Such understanding is vital to help you get some fair ideas about closed-end mutual funds so you can make your own judgment on whether any of these investment types is your cup of tea and fits your risk appetite.