Are you open or closed?
No… I’m not talking about your personality type!
I’m talking about open-end funds versus closed-end funds (CEFs).
It’s a question we often get from readers, so allow me to give you a quick rundown on CEFs and follow that with a few specific CEF investments that yield some healthy dividends.
The ABCs of CEFs
Let’s start by stating what CEFs are not.
They’re not traditional mutual funds. Nor are they ETFs. Consider them somewhere in between.
Structure: Like mutual funds and ETFs, CEFs invest in a basket of underlying stocks that span different sectors, industries, or regions. These stocks represent the fund and give it a Net Asset Value (NAV). And CEFs are actively managed, which means they have the same fees and expenses that other funds do.
Investment & Funding: CEFs usually have a fund management company behind them. At the outset, the company solicits capital from investors through an initial offering. Once the fund is up and running, it’s closed to new capital. If the fund manager wants to raise new money, he can do so through leverage – for example, borrowing money by issuing preferred stock or debt. This leverage is a percentage of the fund’s total assets and needless to say, the amount of leverage influences a fund’s performance in terms. For instance, if preferred stockholders need to be paid interest on their investment, it will affect net income. A fund’s capital gains and losses are also either higher or lower, depending on how much leverage the fund has employed.
Pricing: Like ETFs, CEFs are priced on an intraday basis. By contrast, mutual funds are priced just once a day – at 4:00 p.m. eastern. Importantly, CEFs have a limit on the number of shares available. This means funds can be priced at either a premium or discount to the NAV, depending on supply and demand.
Availability: CEFs trade on major exchanges during the day and can be bought and sold at any time through any brokerage, just like regular stocks. That means the share price is set by the market and can differ from its underlying value – i.e., be undervalued or overvalued, just like other stocks. By contrast, an open-ended fund’s value will correlate to its NAV very closely.
Volatility: Because CEFs don’t create or redeem shares, they generally hold less cash and are less affected by market volatility. As a result, fund managers have more flexibility than their open-end fund counterparts when it comes to buying and selling shares. For example, if a few stocks in an open-end fund manager’s portfolio start tanking, he must sell, too, otherwise it could adversely affect the balance of his portfolio and the fund’s liquidity. But because CEFs trade on the open market and are thus more dependent on supply and demand, a manager can essentially wait it out and let the market reset.
Those are the basics – and one of the other attractive aspects of CEFs is that they tend to pay above-average yields. So let’s take a look at three funds that not only offer capital appreciation, but healthy dividends, too…