Closed-end mutual funds are unique investments that allow you to pool your money with other investors; taking advantage of offerings that you wouldn’t be able to access alone. However, there are important features to understand about closed-end mutual funds.
What are Closed-End Mutual Funds?
Most "regular" mutual funds are open-ended mutual funds. That means that more shares are created and issued by the mutual fund company whenever more people want to invest. To sell these mutual fund shares, you simply turn them back into the mutual fund company, or redeem them. With closed-ended funds, the number of shares in the fund is fixed at issue. To buy the fund you must by the shares from another investor that holds them. To sell the fund, you sell the shares to another investor. Like stocks, this takes place on an open market.
A closed-end mutual fund is a collective investment arrangement. This means that you pool your money with other investors to gain access to investments that wouldn’t be available to you otherwise. If you choose the right investment; the gains can be substantial.
These investments are often targeted towards specific geographic areas or investing themes. For example, a collective investment may be targeted towards an emerging part of Europe or a specific industry theme; like medical technology.
Where can I Purchase Closed-End Mutual Funds
When purchasing closed-end mutual funds, there are a limited amount of shares that are offered to the public, unlike the more traditional open-end mutual funds. When a closed-end fund is new, there will be an initial public offering of a certain number of shares. After that, the shares of the fund trade like other securities on the open market instead of being redeemed or issued by the mutual fund company.
For example, there may be 20 million shares for $20 each offered to the public. Investors can then purchase the closed-end mutual funds, which are initially available through the fund manager. After the initial offering is complete, the shares will be sold in the secondary market (the NYSE or AMEX which mostly sells American closed-end funds).
The Price of Closed End Mutual Funds
There are two factors that make up the price of a closed end mutual fund: value of the investments in the fund and how the market perceives the investment. For example, if technology is a popular investment, a technology based closed-end fund may be priced at a premium. A premium price is when the price of the shares is greater than the underlying value of the individual investments held.
While if the technology segment is undesirable, the investment would be discounted - which may provide opportunities for future investment growth. A discounted price is one where the value of the investments held is greater than the cost of the fund's shares.
Leveraging a Closed End Mutual Fund
When investing in a closed end mutual fund, you can leverage the investment by borrowing funds via a margin account to supplement to investment. If your investment performs well, the results are magnified; greatly enhancing the outcome.
If you’re new to closed-end mutual funds, you may want to start out with a small investment. This will allow you to get a feel for how the process works. Once you’re comfortable, you can up your investment..However, if the investment doesn’t perform well, the negative outcome is also magnified – which increases your loss.