How To Make An Investment In Closed End Funds

Mutual funds are of two types – open end funds and closed end funds. Open end funds are getting more popular among the public in comparison to closed end funds. Both of these funds share the same feature of selling shares to investor and invest their money which suits their target, but this is the only similarity between these two types of mutual funds. Closed end funds are commonly known as CEFs. CEFs are limited in number and they are not issued or redeemed as per the demand of the investor unlike other securities which are traded publicly. The price of these securities changes with change in demand and supply of CEFs in the market.

Closed end funds are traded throughout the day in the stock exchange. As we have discussed earlier the prices fluctuates with the change in demand and supply of CEFs. If investor buys CEFs then the price of the security goes up and if investors show interest in selling them instead of buying then this means that there is increase in supply so it will result in downfall in the price of closed end mutual funds.

After knowing about closed end funds there is one question that arises in the mind is should we invest in closed end funds or not? Nowadays people don’t prefer closed ends funds and reason behind this is the increasing popularity of exchange traded funds and open end funds but it does not mean that we should not invest in closed end funds. Some of the benefits of closed end funds are given as follows:-

  • Investor is offered bonus when the difference between the net asset value and the share price decreases after the investment is made in closed end funds.
  • Open end funds manager has to worry about the factor that the need of cash may arise for the sudden redemption where there is no such need in closed end funds and investor need not to worry about this.
  • Closed end funds generate more income because of the strategy of investing in high income producing asset which results in good returns for the company as well as for investors.

After knowing the benefits of closed end funds you might have made your mind regarding investment in closed end mutual funds but there is a need to know about how to invest in closed end funds and what are the factors which must be kept in mind before investing in a closing end fund to give yourself a better chance of generating money instead of losing it. Those factors are given as follow:-

  • First of all decide in which mutual funds sector you are interested to invest in. Once you decide what type of investment you want in your portfolio, now is the time to evaluate the discount. Discount here is referred as the difference between the share price of funds and its net asset value. Higher the differences more are the chance for you to make good money.
  • Measure the performance of the fund and its returns in last few years. The best way to measure the performance of the fund is by evaluating the returns of the last few years and according to experts fund should be at least five year old before you invest in it.
  • Don’t invest in those closed end funds which are having more than 40% debt in comparison with the total value of assets because high percentage of debt makes the fund a risky investment.
  • There are lots of expenses related with the trading of closed end funds like commission, fund expenses and annual management fees. So to make a better investment and get some good returns one should look for a closed end fund with low expenses and trading in that should be done through a discount broker.
  • Closed end funds are normally invested in bonds to generate heavy income for investor but you should keep in mind the fact that these returns is taxable as income is in the hands of investor and rate is not as low as the rate of tax in the case of dividend.
  • It is recommended by the experts to not to buy the closed end funds through a initial public offer because it is believed that the gap between the fund’s share price and net asset value increases instead of decreasing which means investing in closed end funds through initial public offers is not going to yield favorable results.
  • When you decide your closed end fund compare it with the open end funds and ETF of similar type. Compare fees, performance and expenses involved in the investment.

If you will keep the above factors in mind before investing in a closed end funds you will end up making a good investment and most probably the gap between the fund’s share price and NAV of the fund in which you have invested will be reduced and you will enjoy high returns.

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