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What is a Closed End Fund?

Closed End Funds

Closed End Funds, or CEF’s for short, are often overlooked investments. There are numerous characteristics that make CEF’s different than your typical Mutual Fund. Some investors may find these unique qualities appealing. Today, I’m covering these characteristics, 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; at the end of the article is an 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. For instance, 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 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?

MANAGEMENT

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 manners, an index pegged PASSIVE variety as well as 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 CEF’s-due to the active management, many CEF’s 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 personally own carries a .8% expense ratio.

TRADE AT A DISCOUNT

One of the most appealing aspects of CEF’s 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.

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; as a great deal of CEF’s always trade at a discount.) This discount is possible because a CEF’s 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

Unlike their mutual fund counterparts, CEF’s trade during the day with stocks. So, 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 ETF’s.

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

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’m going to give you a few things to watch out for that you can filter through 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 CEF’s. You might see as high as a 2% expense ratio

To screen for Expense ratios on CEFCONNECT follow this:

Funds Basics then Baseline Expense.

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

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 it’s return; of course, it can also increase the risk to the downside. 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 amount by click on

Fund Basics then click Leverage.

DIVIDENDS

CEF’s 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.

Here is an on-screen broadcast I did discussing Closed End Funds and things to watch out for:

Closed End Fund Screener

REITS are great sources of Dividend, check out this blog for more ideas:

REITS for Income

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