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I am familiar with the workings of a "regular" mutual fund but not a closed end fund. How do closed end mutual funds work compared to a "regular" mutual fund? What are the advantages and disadvantages of a closed end fund?
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I am familiar with the workings of a "regular" mutual fund but not a closed end fund. How do closed end mutual funds work compared to a "regular" mutual fund? What are the advantages and disadvantages of a closed end fund?

An open-end mutual fund can acquire any number of shares based upon the inflow and outflow of money into and out of the fund. It's net asset value (NAV) is published in the newspaper and online based upon the the value of the shares it holds. So, if a fund has 1,000,000 shares of CISCO and CISCO closes at 20, the NAV of that fund is $20,000,000.

A closed-end mutual fund acquires a fixed number of shares at the time it closes (it could have been an open-end fund at one time). This fund may not add to the shares in the fund. So, if our open-end mutual fund with 1,000,000 CISCO shares closes, it will always have 1,000,000 shares except for splits of course. The fund then trades like a stock on a stock exchange and can be traded during the day. The strange thing about a closed end fund is that it will almost always trade at a discount to its NAV ! Wiser men than myself have attempted to answer this seemingly bizarre behavior.

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buy2win wrote:

The fund then trades like a stock on a stock exchange and can be traded during the day. The strange thing about a closed end fund is that it will almost always trade at a discount to its NAV !

It is strange isn't it? But it seems to be true. I think it boils down to liquidity and popularity. Open ended funds are by their very nature more liquid. If a large investor wants to buy, then the fund just buys more of the underlying stocks and sells if he wants to sell (presumably the underlying stocks are liquid.) With a closed end fund that doesn't happen; the investor must find another fund holder who is willing to complete his transaction. So, that makes people less willing to hold the closed end fund.

Another reason is that many closed end funds have no set date when the underlying stocks will be liquidated and the proceeds returned to the investors; or in some cases the liquidation date is many years in the future. Long time spans make it unprofitable for abitraguers (sp?) to step in and bring the NAV in line.

Cheers!
GW
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A closed-end mutual fund acquires a fixed number of shares at the time it closes (it could have been an open-end fund at one time). This fund may not add to the shares in the fund.

Do you mean by this that closed-end funds cannot buy or sell anything within the funds after closing? That is not so. Active trading within a closed-end fund is generally legal and common. The number of outstanding shares of the closed-end fund is fixed (but see below). If you want to get into or out of a closed-end fund, you must find someone to sell you his shares or buy yours. The number of shares of any particular stock held inside the closed-end fund is not fixed. So, in your example, the management of the closed-end fund could sell all of its Cisco and buy, oh say, Intel.

Further, the closed-end fund may sometimes add to the number of its shares outstanding by creating and selling more shares. (Open end funds do that every day when they have more purchases than redemptions.) Bergstrom Capital (BEM), for example, created new shares some years ago. It offered the shares first to existing share holders. Also, a closed-end fund may reduce the number of outstanding shares by buying them on the open market and retiring them. Management may do this to keep a discount from growing too large, or to capture that discount for the benefit of shareholders who do not sell. BEM has done this too. (I have held BEM in my IRA for about twenty years.)

You can read up on closed-end funds at
http://www.icefi.com

http://www.portfolios101.com/portfolios101/closedvsopenmutualfund.htm

http://library.thinkquest.org/C001759/guide/mutual5.htm "Supply and demand determines the price of the closed-end fund. When demand is high, investors are willing to pay a higher price for the fund. When demand is low, the share may sell at a discount." Supply and demand for the shares in the closed end fund's portfolio determine its net asset value per share. Then, supply and demand for shares of the funds itself determine whether those shares sell for more or less than net asset value.

Chips
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Hi, GW!Is it best then to get out of a closed end fund as quickly as possible upon learning of it? Do they ever continue to gain in value long term? It sounds like there is no advantage for the investor to continue to hold a closed end fund. What is the fund managers purpose for doing so? It would seem if there are fewer investors involved and the fund continues to gain in price there are fewer to divide the spoils amongst.

Joanna
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Chips,
Thanks for the references on Closed End Mutual Funds. Since CEF trade like stocks, are they similar to exchange traded funds? I assume one pays a commission to buy and sell a CEF plus a yearly management fee. Does the performance of CEF justify the costs? What type of accounts are CEFs suitable for? Do CEFs pay out large, taxable distributions that open ended mutual funds often pay out?
Mawhinney
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Mawhinney,

Your quite welcome.

Since CEF trade like stocks, are they similar to exchange traded funds? Sorry, I don't know enough about exchange traded funds to comment.

I assume one pays a commission to buy and sell a CEF plus a yearly management fee. Right, commission in and out and annual management fees. Bergstrom (BEM) makes it a point to keep fees very low, unlike most other closed end funds. Try going to forbes.com, searching that site for "Bergstrom". This gets you an article (free) entitled "High-Growth Hotshot" by Michael Freedman, Forbes Magazine, 09.04.00 Another exerpt: "Our advice: Wait until Bergstrom's discount widens to its historical norm, 10%, to buy in. As a long-term investor you stand to do well with this fund, which has logged a 23% annualized return since mid-1990, beating the FORBES closed-end composite by seven percentage points."

Does the performance of CEF justify the costs?
Depends on the fund. My general preference is for no-load, minimum management fees, index funds. My major holdings are Vanguard Index 500 VFINX and Schwab 1000 SNXSX. My holding in BEM was prompted by reading about it in Forbes years ago. Here's the pitch: suppose you had a rich uncle who was willing to manage your money for you in the account where he manages millions of his own dollars. That rich uncle is Erik Bergstrom, of whom you may read in the Forbes site. Unfortunately, Mr. Bergstrom seems to be sidling toward retirement. (The management fee is about 0.5% / year)

Do CEFs pay out large, taxable distributions that open ended mutual funds often pay out? I don't know about the other funds. Another reference on BEM
http://www.closed-endfunds.com/newsreleases/div-dists/divdist62.htm
It says BEM declared a cash dividend of $17.75 per share payable June 5, 2000. Its current policy is to pay about 6% each June. For that reason, I'd hold it only in a tax-deferred account. Mine is in my IRA at Schwab. I reinvest the dividends in more shares with no commission there. Of course, the capital gains on the investment will eventually come out of the IRA and be subject to ordinary income tax rates. (Unless, perish the thought, I expire prematurely, in which case the IRA will pass tax-free to the National Taxpayers Union Foundation, for exposing those scalawags in Congress.)

This post probably should have been in the BEM board, but that board has been inactive for over a year.

Chips, who may very well dump his BEM one day for more VFINX



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JORAYW wrote:
Hi, GW!Is it best then to get out of a closed end fund as quickly as possible upon learning of it? Do they ever continue to gain in value long term?

There is no simple answer. A well managed, low-cost closed end fund could be a very good investment. If you are already in one, then you need to examine past performance very carefully and you need to look at your tax situation. If selling would produce capital gains then you might want to hold on. If the fund is a real dog, then you might want to sell even though you have gains. If you have losses and don't like the fund then by all means sell and let Uncle Sugar underwrite your losses.



It sounds like there is no advantage for the investor to continue to hold a closed end fund. What is the fund managers purpose for doing so?

Commissions and annual fees.

It would seem if there are fewer investors involved and the fund continues to gain in price there are fewer to divide the spoils amongst.

Spoils, if any, are divided based on shares of ownership; so it really doesn't matter how many owners there are.


Disclaimer:

I'm a big fan of S&P500 index funds. I'm no expert at CEF's. I advise you to compare your funds performance to VFINX, Vanguard's S&P500 index fund. It's a very good fund and will give you an idea of what is possible.

Cheers,
GW
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mawhinney wrote:

Since CEF trade like stocks, are they similar to exchange traded funds?

ETF's tend to track their Net Asset Value very closely. That's because anyone with the cash can buy 50,000 shares on the open market and trade them in for the underlying securities. Likewise, anyone can buy the underlying stocks and trade them in for 50,000 shares of the ETF. That mechanism provides motivation for large investors (banks, brokerage houses, Bill Gates, etc. ) to keep an eye on these securities and make the swap when prices get out of line. That's good news for us small investors.

What type of accounts are CEFs suitable for?

ETF's like SPY, the S&P500 spider, are suitable for people who want to invest in an S&P500 index fund, but also want to keep all their money in a brokerage account. SPY are also less likely to genterate capital gains from annual turnover, than are funds like VFINX. (Even though it is true that VFINX is very tax efficient.)

People who trade on short to intermediate term fluctuations tend to prefer CEF's and ETF's over other mutual funds because they can be traded quickly.

Hope that helps.

Cheers!
GW
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Gray Wulff,

Thanks so much for taking the time to answer my question. I had just learned of a fund I own that went to a closed end fund and I wasn't sure what my alternatves were now that it has occured. I like the fund and the managers and feel once the nasdaq gets back on its feet the fund will grow nicely. I think I will continue to hold it for a while longer.

Thanks again,

Joanna
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***People who trade on short to intermediate term fluctuations tend to prefer CEF's and ETF's over other mutual funds because they can be traded quickly.***

The attraction to CEF's has been enhanced by low commision online discount brokers. This is especially noticable in Closed End Bond Funds when can be traded for as little as $5 in and $5 out.
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The strange thing about a closed end fund is that it will almost always trade at a discount to its NAV ! Wiser men than myself have attempted to answer this seemingly bizarre behavior.
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"a closed end fund" Author: buy2win usually inserts a hyphen, but
many other posters fail to do so. Please write "closed-end fund".
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"almost always" Not so; in Barron's you can find many CEFs that are
trading at a substantial premium, e.g. BHY at +31 percent. Why would
anyone buy BHY?
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To Author: JORAYW
I had just learned of a fund I own that went to a closed end fund
and . . .

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I wish you would tell us the name (names?) of your fund.
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What are the advantages and disadvantages of a closed end fund?
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An important advantage: A manager of a closed-end fund does not have to deal with redemptions.
This makes it easier to manage the fund. In an open-end fund, redemptions may force the manager to sell stocks that he would not sell otherwise.
Similarly, the manager of a closed-end fund does not have to deal with unexpected inflows of cash from new investors.
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A disadvantage: I have found it more difficult to obtain detailed information about CEFs than about open-ends.
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