Open and Closed-End Funds

open end fundsOpen end funds are a type of mutual fund that do not have restrictions on the amount of shares the fund can issue. The majority of mutual funds are open-end, providing investors with a useful and convenient investing vehicle. When a fund’s investment manager(s) determine that a fund’s total assets have become too large to effectively execute its stated objective, the fund will be closed to new investors, and in extreme cases, will be closed to new investment by existing fund investors.

Open end funds are a mutual fund issuing unlimited shares of investments in stocks and/or bonds. Purchasing shares creates new ones, whereas selling shares takes them out of circulation. Shares are bought and sold on demand at their net asset value (NAV), which is based on the value of the fund’s underlying securities and is calculated at the end of the trading day. When a large number of shares are redeemed, the fund may sell some of its investments to pay the investor.

Open end funds provide investors an easy, low-cost way to pool their money and purchase a diversified portfolio reflecting a specific investment objective, such as growth and income. Investors do not need a lot of money to gain entry into an open-end fund, making the fund easily accessible for investment.

Open end funds are what you know as a mutual fund. They don’t have a limit as to how many shares they can issue. When an investor purchases shares in a mutual fund, more shares are created, and when somebody sells his or her shares the shares are taken out of circulation. If a large number of shares are sold (called a redemption), the fund may have to sell some of its investments in order to pay the investor.

You can’t watch open end funds in the same way you watch your stocks because they don’t trade on the open market. At the end of each trading day, the funds reprice based on the number of shares bought and sold. Their price is based on the total value of the fund or the net asset value (NAV).

Closed End Funds

Closed-end funds (CEFs) may look similar, but they’re actually very different. A closed-end fund functions much more like an exchange traded fund (ETF) than a mutual fund. It is launched through an IPO in order to raise money and then traded in the open market just like a stock or an ETF. It only issues a set amount of shares and, although their value is also based on the NAV, the actual price of the fund is affected by supply and demand, allowing it to trade at prices above or below its real value.

More than $260 billion is held in the closed-end funds market, yet it is not well known by retail investors. Some funds, like BlackRock Corporate High Yield Fund VI (HYT), pay a dividend of around 8%, making these funds an attractive choice for income investors.

Similarities and Differences Between Open and Closed-End Funds

Both open and closed-end funds are run by portfolio managers with help from analysts. Both types of funds mitigate security-specific risk by holding diversified investments, and by having lower investment and operating costs due to the pooling of investor funds.

However, an open-end fund has unlimited shares issued by the fund, whereas a closed-end fund has a fixed number of shares launched through an initial public offering (IPO) and sold on the open market. Open-end shares do not trade on an exchange, are less liquid, and are priced at the NAV at the trading day’s end. Closed-end shares trade on an exchange and are more liquid; prices trade at a significant discount or premium to the NAV based on supply and demand throughout the trading day.

Open end funds must maintain cash reserves to meet redemptions. Since closed-end funds do not have that requirement, they may invest in illiquid stocks, securities or markets such as real estate. Closed-end funds may impose additional costs through wide bid-ask spreads for illiquid funds, and volatile premium/discount to NAV. Open-end funds typically provide more security, whereas closed-end funds often provide a bigger return.

Closed-end funds trade just like stocks. While open-end funds are priced only once at the end of the day, closed-end funds are traded and priced throughout the day. Closed-end funds also require a brokerage account to buy and sell, while an open-end fund can often be purchased directly through a fund provider.

Summary

Open-end products may represent a safer choice than closed-end funds, but the closed-end products might produce a better return, combining both dividend payments and capital appreciation. Of course, investors should always compare individual products within an asset class; some open-end funds may be more risky than some closed-end funds.

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