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Overview

Closed-end funds (CEFs) are professionally managed investment companies that offer investors an array of benefits unique in the investment world. While often compared to traditional open-end mutual funds, closed-end funds have many distinguishing features. They offer investors numerous ways to generate capital growth income through portfolio performance, dividends and distributions, and through trades in the marketplace at beneficial prices.

CEF shares are listed on securities exchanges and bought and sold in the open market. They typically trade in relation to, but independent of, their underlying net asset values (NAVs). Intra-day trading allows investors to purchase and sell shares of closed-end funds just like the shares of other publicly traded securities. In addition, when shares of closed-end funds trade at prices below their under-lying NAVs (at a discount), investors have the opportunity to enhance the return on their investment by making bargain purchases.

The history of closed-end funds began in 1893, more than 30 years before the first mutual fund was formed in the United States. Currently, there are more than 500 closed-end funds, some of which have management and performance histories that date back over half a century. Many investors hold CEFs for long periods of time, and it is not unusual for shares to be handed down from one generation to the next.

Closed-end funds are truly unique investments and provide investors an important way to achieve their long-term investment goals.

Investment Company Industry

Investment companies have been around for over 100 years; however, the foundation for their current popularity was laid with the passage of the Investment Company Act of 1940 (the 1940 Act). This legislation and subsequent amendments and related rules have provided a rigid, yet workable, framework for millions of individual investors to obtain professional management of a diversified portfolio of securities at a reasonable cost.


There are two principal types of investment companies: open-end and closed-end.

Open-end funds (more commonly known as mutual funds) continuously offer their shares to investors and prospective investors and stand ready to redeem their shares at all times. Transactions in shares of mutual funds are based on their net asset value (NAV), determined at the close of each business day. Sometimes the transaction price includes an adjustment for a sales, redemption or other charge. NAV is the value of the fund's assets less its liabilities divided by the number of the fund's outstanding shares. The invested capital in a mutual fund tends to fluctuate based on investor sentiment.

Closed-end funds have a fixed number of shares outstanding. Following an initial public offering, their shares are traded on an exchange between investors. Transactions in shares of closed-end funds are based on their market price as determined by the forces of supply and demand in the marketplace. Interestingly, the price of a CEF may be above (at a premium to) or below (at a discount to) it's NAV. The transaction price will also include a customary brokerage charge. The invested capital in a closed-end fund is fixed and will change only at the direction of management. Capital can be increased through the issuance of shares in conjunction with a rights offering or through the reinvestment of certain dividend payments. Capital can be reduced when shares of the fund are repurchased in conjunction with a stock repurchase program or tender offer.

If you have had experience with mutual funds, many of the advantages of closed-end funds should be familiar to you.

Diversification - In closed-end funds, you participate in a portfolio that invests in many securities, and this helps to spread market risk. If any one security performs poorly, it shouldn't have a severe impact on your investment.

Professional Management - The portfolio manager or team selects securities and monitors them on a full-time basis. You can participate in closed-end funds without developing investment expertise or devoting hours of time to research on specific issues.

Clear Objectives - Most closed-end funds specialize in either stocks or fixed-income securities and pursue a consistent objective, such as capital appreciation or current income. Some funds are highly specialized, investing in a given region, country or specific type of security. You can select funds with management styles and objectives that match your needs.

Convenience - You may buy or sell shares quickly and easily during the day in any quantity that your brokerage firm permits.

Liquidity - Whether your order is to buy or sell a few shares or several thousand, you should be able to execute your trade in active and competitive bidding.

Economy of Scale -The costs of operating a closed-end fund are divided pro rata among all shareholders. The major ongoing cost, a management fee paid to the investment advisor, is based on assets and is very competitive with the same expense in mutual funds.

Periodic Distributions - Your fund will make distributions according to a prescribed schedule. If you depend on your investments for current income, this will allow you to plan the timing of income. (The actual amounts of income distributed by closed-end funds varies with market conditions and fund performance.)

"Pass Through" Taxation - Like mutual funds, closed-end funds generally do not pay tax at the fund level on amounts distributed to investors. The taxation is said to 'pass through' to the shareholders.

Available For Many Accounts - Like mutual funds, closed-end funds may be purchased in regular brokerage accounts (individual or joint-name), retirement plan accounts, trust accounts or custodial accounts.


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