Closed-End Funds

EXCHANGE-TRADED index funds have soared in popularity since the first U.S. fund was launched in 1993. But ETFs weren’t the first investment funds to be listed on the stock market. That distinction belongs to closed-end funds, which have traded in the U.S. since 1893.

According to the Investment Company Institute, there were some 426 closed-end funds as of September 2023, which collectively managed $243 billion in assets. Municipal bond funds were the largest category, accounting for $79 billion of that total. Indeed, the world of closed-end funds includes a vast array of single-state, tax-free municipal bond funds. For more on closed-ends, check out the Closed-End Fund Association at CEFA.com.

Every closed-end fund has two prices. There’s the price of the publicly traded shares—and then there’s the value of the fund’s assets expressed on a per-share basis, otherwise known as its net asset value. Closed-end fund shares are initially sold at a premium to net asset value, with the premium representing the money earned by the brokerage firms concerned. Often, funds quickly fall to a discount, at which point you might be able to buy a dollar of assets for just 90 cents. An obvious lesson: Never buy a closed-end fund at the initial public offering. There’s a good chance you’ll suffer a steep short-term loss as the fund’s share price goes from a premium above net asset value to a discount.

Another potential pitfall: Many closed-end bond funds use leverage to boost returns. The funds issue short-term debt at relatively low interest rates and then use the proceeds to buy longer-term bonds offering higher yields. The interest rate differential helps pad the yield paid to shareholders. But those higher yields come at a price: When bond prices fall, owners of leveraged closed-end funds will suffer steeper losses than those in unleveraged funds.

Next: Unit Trusts

Previous: Emerging Market Debt

Articles: The Price Isn’t Right and Behind Closed Doors