Closed-end fund

CEFs are the oldest form of pooled investment still used, dating to the 1800s. The Foreign and Colonial Investment Trust was established in the United Kingdom in 1868 and as of 2013 was the oldest CEF still active and traded on the market (London Stock Exchange, under the symbol FCIT). In the United States, closed-end funds sold publicly must be registered under both the Securities Act of 1933 and the Investment Company Act of 1940.

U.S.-based closed-end funds are referred to under the law as closed-end companies and form one of three SEC-recognized types of investment companies along with mutual funds and unit investment trusts.

Like their better-known open-ended cousins, closed-end funds are usually sponsored by a fund management company. The fund's charter, prospectus and the applicable government regulations specify the types of investments the fund manager is permitted to buy. Some funds invest in stocks, others in bonds, and some in very specific assets (for instance, tax-exempt bonds issued by the state of Florida in the USA).

Distinguishing features

A closed-end fund differs from an open-end mutual fund in that:

• Closed-end fund shares are traded on stock exchanges, and can be purchased and sold through brokers at any time during market hours. An open-end fund can usually be traded only by transacting directly with the investment company that manages the fund, at a time of day specified by the investment company, and the dealing price will usually not be known in advance as the fund buys and sells at net asset value for the day's end.
• A closed-end fund usually trades at a premium or discount to the market value of its assets (known as net asset value, or NAV). In contrast, the price of an open-end fund cannot fall below net asset value, because the funds are required to transact with investors only at net asset value.
• Closed-end fund investors who wish to exit the investment can do so only by selling the funds' shares to other investors on stock exchanges. In contrast, open-end funds are redeemed directly by the fund at net asset value.
• In the United States, a closed-end company can own unlisted securities.

Another distinguishing feature of a closed-end fund is the common use of leverage (gearing) to obtain new money to invest after the fund's inception. This can be done by issuing preferred stock, commercial paper or rights offerings. Leverage amplifies gains when the market prices of the fund's investments rise, but it also amplifies losses when market prices decrease. This increases the volatility of a leveraged fund's net asset value, compared with an unleveraged peer.

The amount of leverage a fund uses is expressed as a percent of total fund assets (e.g. if it has a 25% leverage ratio, that means that for each $100 of total assets under management, $75 is equity and $25 is debt). In some cases, fund managers charge management fees based on the total managed assets of the fund, which includes leverage. This further reduces the income benefit of leverage to the common shareholder, while retaining the additional volatility.

Leveraged funds can seem to have higher expense ratios — a common way that investors compare funds — than their non-leveraged peers. Some investment analysts advocate that expenses attributable to the use of leverage should be considered a reduction of investment income rather than an expense, and publish adjusted ratios.

Since stock in closed-end funds is traded like other stock, an investor trading them will pay a brokerage commission similar to that paid when trading other stocks (as opposed to commissions on open-ended mutual funds, where the commission will vary based on the share class chosen and the method of purchasing the fund). In other words, closed-end funds typically do not have sales-based share classes with different commission rates and annual fees. The main exception is loan-participation funds.