What is a Closed End Funds (CEF)?

A closed end fund is an investment fund that has sold a fixed number of shares.

Closed end funds tend to use more leverage, be more volatile, have higher fees, and have higher yields than many traditional, or open-ended funds.

How Do Closed End Funds Work?

At a basic level, CEFs are very similar to the ETFs and mutual funds that are more common in the investment world. A manager or set of managers allocates a pool of money into different investments. Investors buy shares of the funds in a hope that the manager will perform well.

Where closed end funds differ from their “open ended” counterparts is the operation of the fund. Operationally, these funds are very simple to run and manage. A closed end fund simply sells a fixed numbers of shares to investors when the fund is launched, and that amount of shares remains fixed.

Compare that to an ETF or mutual fund, where the number of shares are constantly changing as assets come in to, or leave the fund.

This difference in operations creates some key differences that make CEF’s perform differently than other investments.

Difference Between ETFs, and Closed End Funds

Advantages of Investing in a Closed End Fund

Lower surprise distributions

Because closed end funds never have to meet investor redemption requests, there is a much lower likelihood of unexpected capital gain distributions in closed end funds than ETFs or mutual funds.

For example, here is a story from the Wall Street Journal about ETFs that faced large redemption requests during the coronavirus pandemic that lead to large capital gain distributions for investors in the funds.

Because the buying and selling of closed end funds happens only on the secondary market, CEF’s do not have this potential problem.

No minimum investment amount

Unlike some mutual funds that may have large minimum initial investments for new investors, closed end funds typically provide investors access to advanced investment strategies with no minimums.

For example, BlackRock has several high yield municipal bond mutual funds (such as MAYHX) that have very high minimums for their lower cost institutional share classes, as much as $1 million!

The same strategy can be found in many closed end funds with no minimums.

Drawbacks of Investing in a Closed End Fund

Closed End Funds are more volatile than ETFs and Mutual Funds

Because of their structure, closed end funds can be more volatile than their underlying assets or open-ended funds that invest in similar assets.

Because closed end funds can trade at significant premiums or discounts to the net asset value, or NAV, of their investments, investors in closed-end funds can see much larger swings in the price of the fund’s shares than investors in open-ended funds.

For example, BlackRock Taxable Municipal Bond Trust (ticker: BBN) is a very large CEF with more than $1 billion in assets that invests in municipal bonds.

In December of 2020 the fund was trading at a 9% premium to the net asset value of its investments. Then in March of 2021, as municipal bonds fell out of favor with investors, the fund was trading at a 1% discount to the net asset value of its investments.

Over this time the net asset value of its underlying assets dropped 9% in value, but since the fund was initially trading at a high premium, and that premium went away as investor demand for the shares fell, investors in the fund experienced an extra 10% decline in the value of their investments, or 19% in total (9% from the underlying assets, plus the 10% difference from a 9% premium to a 1% discount).

Chart from CEFconnect

This is an example of how even a very large and established closed-end fund can be much more volatile than its underlying assets.

Closed End Funds can have high fees

Closed-end funds typically have much higher fees for their investors, in the form of interest expense and the fund’s expense ratio, than open-ended funds.

Many closed-end funds use a lot of leverage, and pursue active trading strategies that can lead to expenses of 1% or more each year. Over time, these fees can hurt an investor’s return and lead to underperformance compared to lower cost alternatives like open-ended funds.

To see the impact of these high fees, use our expense ratio calculator!

For example, BBN (the fund used in the example above) charges an annual expense ratio of 1.97%. Compare that to iShares National Municipal bond ETF, an open-ended fund, that has an expense ratio of just 0.07%.

Look at the difference that high fee can make over time! (Image from our expense ratio calculator linked above)

what is a closed end funds

Are Closed End Funds Good Investments?

Because every investor is different and has different needs, it is impossible to say that one investment is “better” than another.

Here is what we can say: Closed end funds have differences that may make them more suitable for risky, speculative investors who are willing to deal with more volatility and pay more fees in exchange for higher potential returns.