Investor Bulletin: Publicly Traded Closed-End Funds

By inergency On Feb 1, 2022

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The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to provide investors information about closed-end funds that are traded on national securities exchanges. It is important to understand them and their risks before investing.

What are closed-end funds?

A closed-end fund is one of three main types of investment companies that the Securities and Exchange Commission regulates. The two other main types of investment companies are open-end funds (including mutual funds and exchange-traded funds or ETFs) and unit investment trusts (UITs).

There are several types of closed-end funds with unique characteristics, such as interval funds or business development companies (BDCs). Read more about those funds at Investor Bulletin: Interval Funds and Investor Bulletin: Publicly Traded BDCs. This Investor Bulletin discusses closed-end funds whose shares can be bought and sold on national securities exchanges, or “publicly traded” closed-end funds.

How are publicly traded closed-end funds similar to other SEC-registered investment funds?

In many ways, closed-end funds are like other investment companies:

They pool money from investors and invest those funds in a variety of stocks, bonds and/or other assets.
They are registered with the SEC and subject to SEC regulation. So they benefit from the same type of investor protections as other registered investment companies do.
Their assets are professionally managed consistent with the fund’s investment objectives and policies. Their managers are investment advisers who are also registered with the SEC.

How are closed-end funds different from other SEC-registered investment funds?

Closed-end funds are also different from other investment companies in important ways:

Unlike traditional mutual funds (or “open-end funds”), closed-end funds are not required to buy back shares from shareholders. As a result, closed-end fund managers do not have the same concerns about constant redemptions as mutual fund managers do and do not have to manage the fund to take into account the possibility of those redemptions. This may give closed-end fund managers more flexibility to invest in less liquid assets, such as private companies, derivatives, or certain debt instruments.
Closed-end funds sell their shares in a public offering. After that, their shares trade on national securities exchanges at market prices. The market price may be greater or less than the market value of the fund’s underlying investments.
Closed-end funds may follow a managed distribution policy. A managed distribution policy means that the funds pay distributions to their shareholders on a set schedule. This helps provide a predictable, but not guaranteed, cash flow to shareholders on a monthly or quarterly basis.

What are some potential risks and benefits of investing in closed-end funds?

As with any investment, you could lose money investing in a closed-end fund.

Access to Less Liquid Investments. Because closed-end funds have more flexibility with their investment portfolios, they may hold a greater percentage of less liquid investments than mutual funds and ETFs. A liquid investment is one that can be sold fairly easily without changing its price. A less liquid investment is one that is more difficult to sell.

What this means for you: This may give you access to some investments that you could not invest in directly. Investing in a wider range of assets can be a good tool for portfolio diversification and may mean that a closed-end fund follows movements of the stock market less closely. In some cases, a closed-end fund may give individual investors the opportunity to invest indirectly in assets that would usually only be available to institutional investors. But it can also increase your risk, because it may be hard for closed-end funds to sell these investments quickly.

Exposure to Leverage or Debt. Closed-end funds may use debt or other leverage more than other types of investment companies to purchase their investments.

What this means for you: Closed-end funds’ use of leverage can increase your returns but can also increase your losses. It can also increase risk and can make the price of closed-end fund shares more volatile.

Paying a Premium or Discount. The market price for closed-end fund shares may be greater or less than the shares’ net asset value (NAV). Shares that sell at a price higher than the NAV are said to be sold at a premium, and shares that sell at a price lower than the NAV are said to be sold at a discount. Closed-end fund shares may sometimes trade at a discount, but may sometimes sell at a premium.

What this means for you: Trading at market price means you may pay more or less for closed-end fund shares than the current value of the fund’s underlying investments. This pricing creates an additional layer of risk and opportunity when owning closed-end fund shares. If you purchase shares at a premium, you are paying more than the current value of the underlying investments. If you purchase shares at a discount, you are paying less than the current value of the underlying investments, but you may be unable to sell the shares other than at a discount.

Receipt of Regular Distributions. Many closed-end funds follow a managed distribution policy. This means that the funds commit to pay a fixed amount of money to their shareholders each month or quarter regardless of the income generated by the fund. These distributions can include income generated by the fund – interest income, dividends, and/or capital gains – but can also include a return of capital if the fund’s income isn’t enough to pay for the distribution.

What this means for you: If the distribution includes a return of capital, it means you are getting back some of your principal, which is the money you originally invested. A distribution that includes a return of capital reduces the fund’s asset base (the money the fund has available to invest) and may make it harder for the fund to make money in the future. It also means that the value of your remaining investment in the fund may decline. When a distribution includes a return of capital, the fund will send you a written notice.

Fees. If an investor buys closed-end fund shares in the initial offering, the investor will pay a sales charge or commission that will be a certain percent of the purchase price. If an investor purchases closed-end fund shares on a securities market, the only transaction fees the investor pays are typical brokerage commissions.

What this means for you: These fees reduce the value of your investment. If you buy closed-end fund shares in the initial offering, you will likely pay higher fees than if you were to buy the shares of the same fund later on a securities exchange. In addition, typically the price of closed-end fund shares immediately decreases after an initial offering, and the shares sell at a discount. If you buy or sell closed-end fund shares on a securities exchange, you will pay a typical brokerage commission, but not any sales loads or purchase or redemption fees.
Regardless of whether you purchase your shares in an initial offering or on a securities exchange, you will pay for the fund’s operating expenses. These expenses – management fees, distribution fees and shareholder services fees – are paid indirectly by shareholders out of fund assets. For a list and explanation of fees associated with a closed-end fund investment, you should review the fee table, which is available in the fund’s prospectus, the annual and semi-annual shareholder reports or other relevant fund documents, or ask your financial professional.

Before you invest in a closed-end fund

Carefully read all of the fund’s available information, including its prospectus and most recent shareholder report. You can get this information by looking at the fund’s filings on the SEC’s EDGAR database, from your investment professional, or directly from the fund.
Understand the fees and expenses you will pay for the fund, and compare them to other investment options.
Be sure that the fund’s investment strategy is consistent with your goals.
Ask Questions:
- Are the closed-end fund shares trading at a discount or premium? What is the history of the share price? Has it been consistently in the same range?
- Does the closed-end fund use leverage or debt to fund its investments? How does it use leverage?
- To what extent does the fund hold illiquid investments? What illiquid investments does it hold?
- Does the closed-end fund follow a managed distribution policy? What is the policy? What is its distribution history? Has the fund paid a return of capital?
- What fees and expenses are my investment dollars subject to?