A closed-end fund is a publicly traded investment company that invests in a variety of securities, such as stocks and bonds. The fund raises capital primarily through an initial public offering (IPO). CEF shares and the proceeds are invested according to the fund’s investment objectives. “Closed” refers to the fact that, once the capital is raised, there are typically no more shares available from the fund sponsor and the issuance of new shares is closed to investors.After the IPO, most closed-end funds are listed on a national exchange, where the fund’s shares are purchased and sold in transactions with other investors, not with the sponsor company itself. When an investor wishes to purchase or sell shares of a closed-end fund, the investor finds buyers or sellers on an exchange such as the New York Stock Exchange (NYSE) or the NASDAQ, just like a stock.
But unlike a stock, the typical closed-end fund represents a strategy with an actively managed selection of holdings. These investments in securities collectively add up to a value, known as its Net Asset Value (NAV), that may be different from the fund’s market price. The market price is determined by market demand and supply, not the fund’s net asset value.
Closed-End Fund Key Concepts
Net Asset Value and Market Price – Net asset value (NAV)is determined using the following formula:
When demand for fund shares exceeds supply, the market price at which a closed-end fund trades may increase to be higher than its underlying net asset value. When there are more fund sellers than buyers (supply exceeds demand), the market price may decline to be lower than its net asset value. The market prices of closed-end fund shares are typically published daily in the financial listings of most newspapers and financial web sites.
Discount/Premium – Many closed-end fund shares trade at prices that differ from each fund’s net asset values for a variety of fundamental and subjective reasons. For example, if the net asset value of a fund is $20, and the fund is selling on an exchange for $18, the fund’s price is said to be at a 10% discount to net asset value. If the same fund is selling for $22, the fund’s price is said to be at a 10% premium to its net asset value.
There are many factors that influence the up-down movement in a fund’s share price, including the fund’s yield or distribution rate, portfolio performance, the demand for a popular strategy or manager, the fund’s sponsor, the availability of timely fund information, an overcrowded marketplace for that type of strategy or style, the use of a managed distribution program, high management fees, a sizable amount or lack of retained earnings or unrealized appreciation, and general market and economic conditions.
Dividends & Distributions – Closed-End funds distribute their earnings to shareholders in two ways, similar to traditional open-end mutual funds. First, income dividends from interest or stock dividends are passed through to shareholders, net of expenses. Most funds, particularly fixed income funds, typically pay out income dividends monthly or quarterly, while some equity funds pay less frequently, often once a year.
When Closed-End fund shares are held in taxable accounts (and the fund investments are not generally exempt from taxes, as municipal bonds are), these income distributions are typically taxable to the shareholder. Depending on the underlying portfolio asset class, these distributions may be taxed as ordinary income, qualified dividend income (QDI), a combination of short and/or long-term capital gains, or return of capital.
Second, realized capital gains (net of realized capital losses) distributions are passed through to shareholders. Most Closed-End funds make these distributions once a year in November or December, though some funds employ a technique called “managed distribution”, in which a portion of capital gains may be paid out with each regular (monthly or quarterly) investment income distribution. Fund companies must seek and receive an exemption from certain SEC rules in order to use a managed distribution program, and must publish estimates of the distribution sources with each payment.
Performance – Fund performance is usually measured as a percentage price increase relative to share price, and as total return on share price including distributions. Funds also may present fund performance based on net asset value (NAV) level changes and total return on net asset value including distributions.
Source: CEF Connect by Nuveen
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