Greater Potential Investment Return
Through a Closed-End Mutual Fund
By Douglas Charney
If
you’re actively saving for your retirement, chances are you may have
a few mutual funds working for you. And most likely, they’re the
typical open-end mutual funds, as these are the ones which are
advertised and, marketed the most. But did you know that there’s
another type of mutual fund available that can also produce
competitive returns? It’s called a closed-end mutual fund, and it
can offer great opportunities for investors.
Unlike
the traditional open-end mutual fund, which issues an unlimited
number of shares, a closed-end mutual fund issues only a limited
number of shares. Once those shares are sold, the fund is closed
(meaning you cannot purchase shares from a broker). If you want to
buy or sell shares, you do so on an exchange market, and the shares
trade like any other share of stock. They do not get sold back to
the fund broker. And, like a stock, the fund’s price is influenced
by the usual stock market forces.
So, why
can closed-end funds be attractive for investors? Several reasons:
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As a general rule,
closed-end fund shares may sell for less than the total value of
their underlying investment portfolio. This discount typically
occurs after all the fund shares have been sold and the only
available shares are for sale on the exchange. In fact,
closed-end funds have sometimes traded at a significant discount
from their net asset value (the value of the portfolio assets
divided by the number of shares owned by investors). As a
result, you can potentially make money not only from price
changes in the fund’s investments, but also from changes in
demand for the share of the fund.
-
Many investors seek to
produce quick gains by trading in and out of closed-end funds.
To put it into perspective, suppose you want to buy a house, and
the market says that house is worth $100,000. If that house were
an open-end fund, you would pay exactly $100,000 for that house
– the price is fixed solely on the value, not on demand for the
house or any other factors.
-
However, if that same
house were a closed-end fund, and you found someone willing to
sell that house for $80,000, you could buy a house that’s worth
$100,000 for a 20% discount. Then, if the market goes up and the
house is now worth $110,000, you could potentially sell it and
realize a $30,000 profit. Anyone who bought a similar house for
$100,000 would only have a $10,000 profit. Of course, this
example is hypothetical and is provided for comparison purposes
only.
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Some closed-end funds
offer a managed distribution policy, or a promise to pay
investors a fixed periodic payment (normally quarterly).
Conversely, open-end funds only distribute gains once a year.
Fund Managers Like Closed-End Funds Too: Both open and
closed-end funds utilize fund managers – someone who opens and runs
the fund. Whereas managers of open-end funds have to concern
themselves with daily purchases and sales by investors, managers of
closed-end funds don’t have such worries. Additionally, they don’t
have to keep cash on hand for unexpected redemptions. That is,
should a lot of people want to sell their shares, managers of
closed-end funds don’t have to liquidate assets in order to buy back
the shares since the shares sell on the stock market and not back to
the manager or broker. The amount of shares investors buy or sell
has no effect on the portfolio. And because closed-end funds don’t
have the same restrictions as open-end funds, closed-end managers
can buy thinly traded and international companies that have the
potential for higher long-term returns, although that comes with
increased risk.
But Wait…High Growth Can Mean High Risk: Even though
closed-end funds offer greater growth potential, they are not
without some element of risk. In fact, the biggest risk can be what
makes them attractive in the first place: the fund’s discount. In
essence, the same discount that lures people to buy can widen in a
fallen market, even as the value of the underlying portfolio also
tumbles. Many investors call this scenario “double trouble.”
Closed-end funds are also subject to brokerage fees and higher
management fees and are less liquid than regular funds, which could
make them much harder to sell.
Even with the element of risk, closed-end mutual funds can be
attractive for investors who are trying to get more growth out of
their assets. In my opinion, few other investments offer the
leveraging opportunity that closed-end funds do, but they need to be
studied carefully and not entered into lightly. You can obtain
information about closed-end mutual funds from newspapers, financial
magazines, websites and books.
Open Your Eyes to Closed-End Funds: Closed-end mutual fund
accounts are relatively easy to establish. You can buy directly from
the broker as a new issue, or you can go to the NYSE or other stock
market exchanges and purchase them via that venue. Note that the
listing for these funds will be in the stock section, not the mutual
fund section.
For many people closed-end mutual funds are a viable way to produce
significant returns, although, as with other investments, there is
no guarantee they will be profitable. Be sure to talk to your
financial advisor before you invest in a closed-end mutual fund to
be sure it is the right choice for your unique needs.
This article is provided by courtesy of
Douglas Charney, a senior
Vice President-Investments with Wachovia Securities in Harrisburg,
PA. He welcomes your comments, and you can reach him at (888)
529-2973. The opinions expressed are those of the author and are not
necessarily those of Wachovia
Securities or it’s affiliates. The material is
distributed solely for informational purposes and is not a
solicitation of an offer to buy any security or instrument or to
participate in any trading strategy. Wachovia Securities, LLC,
Member New York Stock Exchange and SIPC, is a separate nonblank
affiliate of Wachovia Corporation. C2007 Wachovia Securities, LLC.
[This article is available at no-cost, on a non-exclusive basis.
Contact PR/PR at 407-299-6128 for details and
requirements.]
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