What is a closed-end fund?

Introduction

A closed-end fund or "CEF" is one of the nine different types of investment funds in the U.S., as explained in our educational article investment fund types. There are currently 465 closed-end funds with a total market capitalization of $264,005,404,176.   See our list of closed-end funds. You can screen closed-end funds using our closed-end fund screener.

Closed-end funds are not nearly as popular as mutual funds and exchange traded funds ("ETFs"). Mutual funds historically have been the most popular investment fund type in America, and ETFs have become increasingly popular over the past 20 years as investors have embraced index investing. So the amount of attention that is paid to closed-end funds is often small compared to mutual funds and ETFs.

Like an ETF, closed-end funds are traded on a stock exchange, and regulated by the U.S. Securities and Exchange Commission. The market price of a closed-end fund share fluctuates like that of other publicly traded securities and is determined by supply and demand in the marketplace. You buy and sell shares of a closed-end fund and an ETF just like you do a stock.

The term "closed-end" refers to the fact that the fund does not regularly sell shares to investors in the normal course of trading. Mutual funds are "open-end" funds, because an investor who wants to own a part of a mutual fund gives the mutual fund cash and the mutual fund then issues additional shares in the mutual fund to the investor. Similarly, investors in a mutual fund sell their shares back to the mutual fund directly, thus reducing the number of outstanding shares. So the number of shares outstanding in a mutual fund changes every day, and is "open-ended".

A closed-end fund, however, has a fixed number of shares. A closed-end fund is created by issuing a fixed number of common shares to investors during an initial public offering. Once issued, shares of a closed-end fund generally are bought and sold by investors in the open market and are not purchased or redeemed directly by the fund. So the number of shares is "closed".

The term "closed-end" doesn't mean that the number of shares outstanding NEVER changes. Some closed-end funds will complete a subsequent issuance of common shares through a "secondary" or follow-on public offering. Many closed-end funds also have dividend reinvestment plans, in which any dividends earned by an investor can by reinvested in the fund by having the fund issue additional shares of the fund in lieu of a cash payment. Some closed-end funds also adopt stock repurchase programs, similar to the way that large corporations will periodically repurchase their own shares as a way to stimulate the demand for the shares, and hopefully the market price.

ETFs are not closed-end funds because ETFs have a built in mechanism to issue (and/or redeem) shares in response to market demand. So the number of shares outstanding of an ETF can change at any time. So like mutual funds, ETFs are also "open-end funds".

Unlike ETFs, which primarily make investment decisions by mechanically tracking an index, closed-end funds are actively managed by a portfolio manager. So before buying shares in a closed-end fund, every investor has to decide what their opinion is about active versus passive (i.e. index) investing. You can read more in our article active verus passive investing.

Closed-end funds pursue all kinds of investment strategies. Here is a summary of the closed-end funds by category:

Category1Fund CountMarket capitalization%
Alternatives28$18,994,447,5517%
Asset Allocation44$23,066,847,9589%
Commodities4$12,027,034,0575%
Global Equity43$17,570,004,8757%
Global Fixed Income39$17,841,411,3367%
Special Security Types34$18,706,274,9967%
US Equity 52$44,720,550,05417%
US Fixed Income221$111,078,833,34942%
Total465$264,005,404,176100%

One thing that sticks out in the above table is that most closed-end funds are fixed income funds (see the high number of US Fixed Income and Global Fixed Income CEFs). Also, note that there really aren't that many U.S. equity closed-end funds.

Let's look a little closer at what investments they are pursuing by summarizing closed-end funds using our category2:

Category1Category2Fund CountMarket capitalization%
AlternativesLong/short debt1$533,514,0790%
AlternativesLong/short equity1$395,981,3530%
Alternatives Market Neutral1$125,419,2290%
AlternativesOptions25$17,939,532,8907%
Asset AllocationEmerging markets1$73,628,5800%
Asset AllocationGlobal17$8,804,046,9743%
Asset AllocationUS26$14,189,172,4045%
CommoditiesBroad market1$4,753,040,6082%
CommoditiesPrecious metals3$7,273,993,4493%
Global EquityEmerging markets3$729,722,6220%
Global EquityEurope3$488,310,7670%
Global EquityGlobal9$6,491,058,5722%
Global EquityGlobal ex-US2$789,158,3390%
Global EquitySingle country15$4,026,414,1342%
Global EquitySingle industry8$2,508,055,3011%
Global Equity Single sector3$2,537,285,1401%
Global Fixed IncomeEmerging markets7$2,127,944,4231%
Global Fixed IncomeGlobal31$14,717,729,9266%
Global Fixed Income Global ex-US1$995,736,9870%
Special Security TypesClosed end funds2$506,078,3240%
Special Security TypesConvertible bonds4$1,240,411,7770%
Special Security TypesMLPs12$5,288,684,4292%
Special Security TypesPreferred stock16$11,671,100,4664%
US Equity Broad market20$20,191,091,4628%
US EquityClosed end funds1$203,710,5860%
US EquitySingle industry4$3,265,033,4691%
US Equity Single sector24$17,177,454,8777%
US EquityThematic3$3,883,259,6601%
US Fixed Income Bank loans27$11,127,787,2614%
US Fixed Income Broad market34$20,653,610,9108%
US Fixed IncomeCorporate bonds23$9,341,505,9154%
US Fixed Income Mortgage backed8$1,300,915,8450%
US Fixed IncomeMunicipal bonds126$67,446,066,30526%
US Fixed Income U.S. treasury bonds3$1,208,947,1130%
Total465$264,005,404,176100%

Closed-end funds have been around a long time. Let's look at the launch date of the closed-end funds currently in our database:

Year of InceptionCount
19293
19681
19711
19731
19781
19842
19852
19864
198717
198817
198913
199011
19917
199219
19935
199429
19957
19961
19973
19989
19998
200119
200230
200334
200433
200519
200610
200723
20082
20098
201011
201112
201220
201317
201410
20155
20166
201710
20183
201911
202011
202110
Total465

Note that in recent years there have not been very many closed-end funds launched, as ETFs have become the more popular fund type to launch. In recent years, there have been hundreds of ETFs launched every year - see the data at what is an ETF?

Closed-end funds use leverage

Another important thing to understand about closed-end funds is that almost 2/3rds of all closed-end funds use leverage to magnify the returns of the common stockholders of the fund. One way that a closed-end fund uses leverage is by having the fund issue debt or preferred stock. This is referred to as "structural leverage".

The amount of debt or preferred stock that a closed-end fund can issue is limited by the Investment Company Act of 1940 to a maximum of 50 percent and 33 1/3 percent of overall fund assets for preferred shares and debt, respectively. So a closed-end fund with $50,000,000 in common stockholder's equity can issue preferred stock totally $50,000,000, bringing the fund's total assets to $100,000,000. Different people use different terms to describe how much leverage this represents. We use the term "leverage factor", which in this example would be 2.00 (because total assets are twice the amount of common stockholder's equity). But other people might refer to this as "50% leverage". There is also a lot of discussion of "asset coverage" - the fund in this example would have an asset coverage of 200%.

Here is a summary of the current leverage factors of closed-end funds:

Leverage Factor RangeCount
1 to 1.25176
1.25 to 1.50137
1.51 to 2.0150
2.5+2

Closed-end funds are permitted to issue one class of preferred stock. Preferred stock differs from common shares in that preferred shareholders are paid dividends but do not share in the gains and losses of the fund. Most publicly traded preferred stock is issued with a fixed dividend rate, but closed-end funds often issue preferred stock with variable dividend rates. Some closed-end funds will issue "auction preferred stock", which is where the dividend rate is reset periodically according to the results of an auction run by an independent auction agent. But in recent years, the amount of auction preferred stock has decreased significantly.

Closed-end funds also borrow money directly from banks or they issue debt in the form of a note or a bond. Closed-end funds are using different leverage strategies - some borrow money, some issue preferred stock, and some do both.

Closed-end funds also have different strategies to help them manage their interest rate risk. Some closed-end funds will issue a variable rate preferred stock or try to borrow money at a variable rate. Other closed-end funds try to lock in their interest rates for longer periods, especially when interest rates are low. It can be tricky to use structural leverage, because the fund is borrowing money at one interest rate (or dividend rate in the case of preferred stock) to invest it in securities such as bonds and other fixed income investments that pay interest at another rate. The fund is hoping that it can achieve a "spread" between the amount it is earning on its investments compared to the amount it is paying on its borrowings. It isn't always easy.

In addition to the structural leverage, some closed-end funds also use "portfolio leverage". Portfolio leverage is where the fund invests in certain specialized securities that create leverage. Types of closed-end fund portfolio leverage include certain types of derivatives, reverse repurchase agreements, and tender option bonds. But most closed-end funds use structural leverage rather than portfolio leverage.

Closed-end fund leverage is significantly different in nature than the leverage used by leveraged ETFs. Since ETFs are not allowed to use structural leverage, ETFs use portfolio leverage. Specifically, leveraged ETFs typically use swap agreements (a form of derivative) to achieve leverage. We are not currently aware of any closed-end funds using swap agreements in the manner of a leveraged ETF. You can read more about leveraged ETFs in our educational article what is a leveraged ETF?

Closed-end funds can trade at a significant discount to NAV

One important thing to monitor with a closed-end fund is how closely the shares of the fund are trading compared to the fund's net asset value per share, or NAV. A fund's NAV is just the total of the fund's assets minus any liabilities, divided by the number of shares outstanding. The fund's NAV is calculated daily. At times, shares of a closed-end fund can trade at a significant premium or discount to it's net asset value. Remember, a close-end fund is traded on an exchange, so the market price is determined by supply and demand on the exchange.

This is in sharp contrast to a mutual fund. Investors buy and sell shares of a mutual fund by directly interacting with the mutual fund, and the share price is always at the mutual fund's last end of day NAV. So by design mutual fund shares never trade at a discount or premium.

Like closed-end funds, ETFs are traded on a stock exchange, so ETFs also can trade at a premium or discount to NAV. However, ETFs usually trade at or near their NAV, because ETFs are constantly issuing or redeeming shares in response to market demand, with the intent of keeping the share's market price close to the fund's NAV. This special feature of an ETF is explained in our article ETF mechanics.

Here is a summary of how closed-end funds are currently trading compared to their NAV values:

Market price vs NAVCount%
No data8117%
At NAV31%
Discount23350%
Premium14832%
Total465100%

Let's break it out a little further:

Market price vs NAVCount%
31%
No data8117%
0% to 5% premium9120%
5% to 10% premium337%
10% to 15% premium82%
15%+ premium163%
0% to 5% discount12226%
5% to 10% discount7516%
10% to 15% discount194%
15%+ discount174%
Total465100%

Closed-end fund fees

Closed-end funds usually have management fees that are significantly higher than an ETF or mutual fund. This is true for several reasons:

When we say that a closed-end fund can be complicated, we are referring to all the tasks that potentially can be involved with managing a fund. In addition to managing the investment portfolio, a closed-end fund can also be involved in issuing debt, issuing preferred stock, buying back shares under a share repurchase program, and managing a dividend reinvestment program. An ETF that tracks an index is much simpler in nature.

Closed-end funds especially seem to have high fees compared to index ETFs. Competition in the ETF industry has caused the average fee on popular index ETFs to drop significantly over the past ten years. So you can now buy an ETF that tracks a broad market index like the S&P 500 and pay almost nothing in fees.

Closed-end fund dividends

Closed-end funds can have high dividend rates. The average dividend yield of the 465 closed-end funds in our database is 6.13%. Keep in mind that as shown above most CEFs invest in fixed-income securities so a high dividend rate is expected compared to a mutual fund or an ETF that is investing in common stocks.

One thing that is unique to closed-end funds is that many closed-end funds have adopted a "managed distributions" policy under which they make regular distributions at a fixed, pre-determined rate, before knowing what the fund's net investment income will be. Almost all mutual funds and ETFs declare and pay dividends once they know how much income they have made.

In contrast, some closed-end funds have adopted a managed distributions policy of paying out dividends at a rate that may or may not be less than the fund's net investment income. At the end of the fund's accounting year, the fund will ultimately know whether they paid out dividends that were more or less than the fund's net investment income. During this year end accounting, the fund's dividends are categorized as dividends based on net investment income, or short or long-term capital gains, or return of capital. If a fund's dividends end up being categorized as a return of capital, it means that the fund paid out more dividends than they had income, so the fund in essence was just giving the investor money back for no reason.

Business Development Companies

A business development company, or "BDC", is a type of closed-end fund. But because of their unique attributes, we include BDCs in a separate category than closed-end funds. You can read more about BDCs in our article what is a BDC?

Key Takeaways

Here are the key attributes of a closed-end fund that you need to memorize and have a clear understanding of:


All data is a live query from our database. The wording was last updated: 10/27/2020.

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