What is a Closed End Fund?

stock chart with pen and paper

Closed End Funds

Closed End Funds, or CEF’s for short, are investment tools that many overlook. They are great for dividend returns and cash flow. You can not only purchase equities as CEFs, but bonds as well.

Most have heard of Mutual Funds, how are CEFs different?

I’ll be covering that today, along with a few things to look out for before purchasing CEF’s.

In addition, I’ll provide a link to, in my opinion, the best closed end fund screener available. This screener helps you filter out unsuitable CEF’s. Down below is a video example of me walking through a CEF analysis over on CefConnect.


Initial Public Offering

The life of a CEF begins like a stock, with an Initial Public Offering. At the IPO, a fixed amount of shares are issued and sold. Unlike Mutual funds, capital doesn’t flow in and out of CEF’s. Shares aren’t created when investors buy or sell; as stated above, they are FIXED. Contrast this with mutual funds whose shares aren’t fixed and one can create as many as they want. I personally see the fixed number of shares in CEF’s as a positive.

How many times have you bought a stock where they dilute the shares and send your price falling?

How is a Closed End Fund managed?

CEF’s are usually actively managed. On the other hand, ETF’s and Mutual Funds come in both flavors, an index pegged passive variety and an active one.

Of course, it’s reasonable that a fund manager is paid for their work and time, active management is never free. This is one of the main disadvantages of CEFs-due to the active management, many CEFs carry expense ratios that are quite high. I’ve seen expense ratios all the way up to a whopping 2.5%. The Municipal Bond CEF that I own carries a 0.8% expense ratio.

Trading at a Discount

One of the most appealing aspects of CEFs is the fact they often trade at a substantial discount. In other words, the market price for the CEF is less than the total net asset value or NAV. Some people wait for a CEF to trade below NAV before buying. However, keep in mind, you need to look at historical trend where this is concerned. Many CEFs tend to always trade below NAV, many others tend to trade above NAV. Don’t wrongly believe you are getting a deal before looking at this.

What is Net Asset Value?

It’s how much the total assets in the fund are worth (Please keep in mind, just because a CEF is trading at a discount doesn’t make it a good investment) This discount is possible because a CEFs price is determined by the competing market of buyers and sellers. For whatever reason, let’s say there’s a sudden surge in demand, then the price goes dramatically above the NAV. The opposite is true if there is a sudden drop in demand.

This is a yet another characteristic that makes them different than a MUTUAL FUND which trades at NAV.

Buying and Selling a CEF

Unlike their mutual fund counterparts, CEFs trade during the day with stocks. No need to worry about wanting to sell during market hours and not being able to get out if you’d like. This characteristic makes them closer to stocks or ETFs.

Now that we know a little about CEF’s, let’s look at how to run a screen on them and pick the good from the bad.


Using a Closed End Fund Screener

Closed End Fund Screener

Don’t get lured into CEF’s based on high yields without doing some serious research. There are many great CEF’s; however, there are also a lot of bad apples in the CEF space. I’ve found the best site to screen for CEF’s is cefconnect.com:

https://www.cefconnect.com/closed-end-funds-screener

I’ll share a few things to watch out for that you can filter out via CefConnect.

EXPENSE RATIO:

This is pretty self explanatory. If you’re used to holding passive index funds, then you may get sticker shock when it comes to CEFs. You might see an expense ration as high as a 2%.

To screen for Expense ratios on CEFCONNECT follow this instructions:

Funds Basics then Baseline Expense.

Set the expense ratio filter so you won’t see those funds with over 1% Expense Ratio.

VOLUME:

The next consideration is Volume. Be careful not to purchase a CEF that has low liquidity or volume. If the volume is too low and you are someone who trades out of positions often, you may not be able to get out as quickly as you’d like. To find the VOLUME:

FUND BASICS, then Avg daily volume.

***By the way, I always recommend using a Limit Order when buying CEF’s due to the volume issues.

LEVERAGE:

The majority of CEF’s use leverage. This leverage can allow the fund to increase its return; of course, it can also increase the downside risks or max drawdown. However, do understand, the fund can’t use but a maximum amount of leverage. This maximum leverage is equal to about 33.33% of debt.

On the CEF connect page, you can view each CEF’s leverage by clicking on

Fund Basics then click Leverage.

DIVIDENDS

CEFs can offer big, tasty distributions. To see the distribution follow this order:

Distributions then Distribution rate

Now, the great thing about my CEF is it is a Municipal Bond CEF, so some of my distribution is tax free. CEF connect even has a space on the individual CEF page that you can calculate the tax-free equivalent yield.

Closing Thoughts

Hopefully you got something out of this Closed End Fund article. I like the monthly income they throw off. However, keep in mind active CEFs are a bit more difficult to navigate and understand, do your homework. There are many CEFs out there that are quite risky due to all the leverage and high expense ratios.

If you’d like other sources of cash flow and income check out my REIT article. REITS are great sources of Dividends.

REITS for Income

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