What is a Closed-End Fund? - Definition & Examples

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

In this lesson we will look at what a closed-end fund is and how it is structured. We all also review how it combines elements of both mutual funds and stocks.

Closed-End Fund

Steve's father passed away last year, and as part of his inheritance he received an investment labeled 'Closed-End Fund'. Most of the portfolio is made up of stocks and mutual funds, but this one is a mystery to Steve. Let's help Steve understand what a closed-end fund is, how it operates, and what he can do with the investment.

Definition

A closed-end fund is an investment company that blends aspects of shares of stock and open-end funds such as mutual funds. The closed-end fund begins when an investment company raises capital through an initial public offering or IPO.

At the time of the IPO, investors trade money for shares in the closed-end fund. This fixed amount is directed to a number of investment assets according to the investment advisor's management plan. Closed-end funds are typically organized around specific type of investments like generating returns with as little tax burden as possible, real estate, energy, or emerging markets.

These funds are bought and sold through a brokerage account in a similar manner to stocks. Because of this, the price of the shares change throughout the day based on investor activity in the market, unlike mutual funds, which are only priced once at the conclusion of each business day.

Trading

Back to Steve. He has this investment that was created like it were a stock, but it effectively behaves like a mutual fund with an advisor buying and selling the investments inside the fund. What can he do with it?

With a mutual fund, shares of the fund are sold to the investor by the mutual fund company. When the investor sells the shares, the mutual fund company makes the appropriate sale of assets and returns cash to the investor.

In a closed-end fund this isn't the case. This is where trading acts more like a stock. Rather than sell the shares back to the investment company, Steve can sell the shares to another investor through his brokerage.

Closed-end fund prices are determined by supply and demand. The fund has an underlying Net Asset Value or NAV, but the actual price the shares sell for is based on what investors are willing to pay for those shares.

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