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Open-end vs. closed-end funds

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Open and closed-end funds share many similarities. Both are typically mutual funds that are professionally managed and can be utilized to construct diversified portfolios. However, it is crucial for investors to be aware of the key distinctions between these two types of funds.

What is an open-end fund?

An-end fund creates new shares when investors make purchases and removes shares from circulation when they make sales. There is no limit to the number of shares that can be issued in an open-end fund.

Most mutual funds are classified as open-end funds and can be purchased through an online broker or directly from the fund company. Open-end funds are bought and sold at their net asset value (NAV), which is calculated at the end of each trading day. Due to this, open-end funds can only be bought and sold at the close of each day’s trading session. Therefore, if you place an order after the market has closed, you will receive the closing NAV for the next trading day as your price.

Types of open-end funds

Most mutual funds are open-end funds. When you purchase a mutual fund, you are issued new fund shares, which are then retired when you sell them. Exchange-traded funds (ETFs), on the other hand, are typically also open-end funds, although they can be structured as unit investment trusts (UITs) as well.

ETFs, similar to stocks, trade throughout the day, while mutual funds are only traded at their net asset value (NAV) at the end of the day.

What is a closed-end fund?

Closed-end funds, although lesser known, have a rich history spanning over a century. These funds have a fixed number of shares and are traded among investors on an exchange. Similar to stocks, their share prices are determined by supply and demand, often resulting in trading at a discount or premium to their NAVs.

There are various reasons why closed-end funds may trade at a premium or discount. A highly skilled fund manager with a proven track record of outperforming the market can drive the fund to trade at a premium. Conversely, a fund with significant unrealized capital gains may trade at a discount due to potential tax liabilities. Additionally, the discount may reflect investors’ anticipation of declines in the fund’s holdings, particularly in less popular sectors.

When closed-end funds trade at a discount to their net asset value (NAV), investors have the opportunity to capitalize on this discount. In fact, some professional investors specialize in purchasing closed-end funds that are trading at a discount, subsequently liquidating the fund’s assets to profit from the price difference.

At the end of 2022, there were 441 closed-end funds, collectively holding assets worth $252 billion, as reported by the Investment Company Institute.

Types of closed-end funds

According to ICI, while closed-end funds can hold a variety of securities, the majority, around 61 percent, are bond funds. As for the remaining 39 percent, they consist of equity closed-end funds. This composition highlights the prevalence of bond funds in the closed-end fund market as of the end of 2022.

Key differences between open-end and closed-end funds

Although open-end and closed-end funds are commonly offered as mutual funds, there are significant distinctions between the two. These variances encompass various aspects and highlight their unique characteristics.

  • Shares – In an open-end fund, shares are regularly issued and retired. When someone wants to buy the fund, new shares are issued, and when someone wants to sell, shares are retired. On the other hand, a closed-end fund only issues shares when it is launched. New investors must buy shares from existing investors, and the price of the fund is determined by supply and demand.
  • Trading – In an open-end mutual fund, shares can be purchased and sold daily at the fund’s closing NAV. On the other hand, closed-end funds trade based on supply and demand throughout the day, potentially at a premium or discount to the fund’s NAV. This distinction allows for greater flexibility and potential for price fluctuations in closed-end funds compared to the fixed pricing of open-end funds.
  • Popularity – Open-end funds are far more prevalent than closed-end funds. As per ICI, closed-end funds held a modest $252 billion in assets by the end of 2022, in contrast to the trillions amassed by open-end funds.

Bottom line

Open-end and closed-end funds primarily differ in their buying and selling mechanisms. Closed-end funds are akin to stocks, their trading influenced by supply and demand. Conversely, open-end funds are traded at the end of each trading day based on their NAV.

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