Guide to Investing in Closed-End Funds
Advantages of Closed-End Funds
Since they do not need to manage inflows and outflows of assets, closed-end funds can generally remain fully invested at all times. In contrast, open-end funds must manage continuous cash flows. For example, if the shareholder of an open-end fund wishes to sell shares of the fund, the mutual fund will redeem shares at NAV. Also, open-end funds generally offer new shares on an ongoing basis to new investors.
Ability to Leverage
Many CEFs may issue senior securities or borrow money to "leverage" their investment position. This strategy gives these CEFs the potential to enhance yield and to offer higher levels of current income in comparison to most open-end funds.
Premiums and Discounts
At any given point in time, a CEF's share price may be above or below its underlying NAV. These premiums or discounts may be the result of such factors as the demand for the yield being offered, relative historical performance, number of funds in a respective peer group, credit quality of the portfolio and/or investor perception or confidence in the fund's manager.
It may be advantageous to purchase a fund when it is trading at a discount to its NAV, as more than a dollar of net assets goes to work for every dollar invested. Therefore, the yield on the stock price will be higher than that on the net asset value of the portfolio. As a discount begins to narrow, investors will also have greater potential for capital appreciation. Of course there is no assurance that the discount will narrow.
CEFs are typically listed on a major exchange such as the New York Stock Exchange or the American Stock Exchange. A listing provides the benefit of liquidity and the convenience of being able to track an investment – via select newspapers and electronic services – using its assigned ticker symbol. With closed-end funds, an investor can purchase shares throughout the trading day at the current market price, as opposed to once a day at the close of business at NAV.
Most CEFs distribute income on a monthly or quarterly basis. Investors generally have the option of receiving cash distributions in cash or having their dividends reinvested. By automatically reinvesting dividends, investors purchase additional fund shares on an ongoing basis, and have the advantage of compounding their returns as invested capital. Over time, this has the potential to lead to higher future returns.
As a CEF trades on an exchange with a fixed number of shares there are no ongoing costs associated with distributing those shares. Because of this, CEFs may have lower expense ratios than open-end funds. As time goes on, a lower fee structure can help benefit investment performance.
This guide is not to be construed as a solicitation or an offer to buy or sell securities. The views contained herein are those of BlackRock and are based on information obtained by BlackRock from sources that are believed to be reliable. This material should not be considered tax, investment, legal or other professional advice. The information herein is not necessarily all-inclusive and is not guaranteed as to accuracy. Reliance upon information in this guide is at the sole discretion of the reader. Past performance does not guarantee future results. No assurance can be given that a fund will achieve its investment objective. The investment return and principal value of an investment will fluctuate, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.