What is a Closed-End Fund?
One of the best ways to define a closed-end fund is to state what it most definitely is not: A closed-end fund is not a mutual fund, which by its very nature is open-ended, continually offering new shares for sale to the investing public. In addition to being much better known than closed-end funds--thanks to millions spent in sales promotion--mutual funds also operate differently. Their purchase price, for example, is based on the net asset value per share (NAV)--meaning the total net assets of the fund divided by the number of its outstanding shares, plus, for load funds, a sales charge. In the case of the so-called no-load funds--those without a sales commission--shares are generally bought and redeemed at their net asset value.
Closed-end funds, on the other hand, do not continue to sell new shares endlessly as the mutual funds strive to do. Closed-end funds issue--and this concept is essential to understand--a fixed amount of stock. In this respect, they are just like any industrial firm or utility which, with the exception of splits or additional offerings of stock, always has the same number of shares outstanding. Closed-end fund shares trade in the open market exactly like the shares of any publicly traded company.
There is generally only one way to buy or sell shares in a closed-end fund--in the open market. (Some exceptions occur during the original offering, when shares are offered directly from underwriting brokerage firms, or during a rights offering--when current shareholders have the right to subscribe to [buy] additional shares from the fund.). This is another factor that differentiates the closed-end fund from the mutual fund. An investor purchases a mutual fund from the fund itself or through its sales agents, and when the investor sells his or her shares, they are redeemed by the fund. On the other hand, trading in closed-end funds, either on the buy or sell side, is done in the open market--on the stock exchanges or in the over-the-counter markets. It is fundamental to remember that shares of closed-end funds are not redeemed at their net asset value, as are shares in open-end funds. Rather, they are bought and sold at the price the general market places on them. That price could be at net asset value, above it, or, as is often the case, below it, meaning at discounts.
An additional difference between mutual funds and closed-end funds can be found in the way in which they are capitalized. Mutual funds' balance sheets consist of only common stock while a closed-end fund can be capitalized with preferred stock and/or debt.
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