Unlike mutual funds, closed-end funds are traded on stock exchanges or over the counter. They may also be purchased at market price as opposed to the price of the underlying security. Closed-end funds have advantages and disadvantages. The experience and high skills of their managers helps them to create highly diversified portfolios. They also trade daily but have several disadvantages as well. Trading in closed-end funds is often volatile in nature. Use of leverage in trading of closed-end funds could be very challenging due in part to the high level of volatility.
What Are Closed End Funds
Closed end funds are investment vehicles run by professional asset managers. Such funds do not accept new money from potential investors. Shares of closed end funds are no longer available for purchase to the public. However, they may be purchased from investors in the fund interested in selling their shares. This means that the managers of closed-end funds can only invest the initial money raised through the initial public offering. The number of shares of closed end funds does not increase due to investor demand.
Pros of Closed-end funds
Closed-end funds are managed by professional money managers. The managers generally maintain a well-diversified portfolio of investments in different asset classes including stocks and other fixed-income securities. Closed-end funds offer the investor potentials for capital appreciation without additional taxes. Closed end funds are traded daily on the stock exchanges just like ordinary stocks are.
Other Advantages of Closed-end Funds
Closed end funds are traded daily on stock exchanges just like securities. Because of that, they are very liquid trading instruments. This creates an attractive condition for other investors to want to participate in trading such assets. This in turn leads to flexibility in buying and selling of this asset. There is additional advantage offered by closed end funds. There is a higher possibility of achieving higher yield on income compared to other capital market funds.
Disadvantages of Closed-end Funds
Shares of closed end funds in secondary markets are often accompanied by high volatility in trading. Prices may swing from one high value to a low value point, all in one day's trading action. There are varying levels of risks associated with each closed end fund. Trading in such portfolios requires research and analysis before such investment.
Other Disadvantages of Closed-end Funds
Use of leverage in trading closed-end funds can create undesired adverse effects on the fund. This is particularly challenging due to sensitivity to interest rates. There are also problems when trading in low volumes; often low-volume trades can make it harder for quick sell action. More risks are carried by sections with high share values; this problem is facilitated by high price volatility. There is also a disadvantage with redemption of shares. There are no redemption privileges, which often help to align prices with the net asset value.
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