Closed-end management companies are similar to open-end management companies. Both pool investor money and invest it according to the fund’s objectives, aiming to generate investment returns. The key difference is how they’re structured (capitalized) and how investors buy and sell shares.
Commonly called closed-end funds, these pooled investments are first offered to investors in the primary market and then trade in the secondary market. This is how most securities trade - on a negotiable basis - including common stock and debt securities.
Unlike mutual funds, closed-end funds are not subject to sales charges (loads). Instead, secondary-market transactions are subject to commissions. Closed-end funds can also be purchased on margin (using borrowed money) and sold short*.
*A short sale involves selling borrowed securities, typically as a way to bet against that security.
When closed-end shares are sold in the primary market, the prospectus rule applies. Every purchaser must receive a prospectus*, which provides detailed information about the issuer and the security being sold. After the primary offering, the issuer’s role shifts to operating the fund. Like mutual funds, the fund manager’s goal is to manage the portfolio to maximize investors’ returns.
*Delivering a prospectus is no longer required once the primary offering is finished and the shares are solely trading in the secondary market.
Like mutual funds, closed-end funds calculate net asset value (NAV). NAV reflects the total value of the fund’s portfolio (on a per-share basis). However, NAV is not necessarily the price investors pay or receive in the market. For closed-end funds, NAV is best thought of as a reference point that helps you compare the fund’s market price to the value of its underlying holdings.
Because closed-end shares trade in the secondary market, their price moves with supply and demand:
NAV for closed-end funds is similar to how Kelley Blue Book works for cars. Suppose Kelley Blue Book lists your car at $10,000. That’s a useful benchmark, but the actual selling price depends on what buyers are willing to pay. Closed-end fund NAV works the same way: it’s a “book value” reference, while the market sets the trading price.
A closed-end fund’s market price can be higher than, lower than, or equal to NAV. Ultimately, market demand determines the price. This differs from open-end funds, where NAV is the minimum price an investor will pay for mutual fund shares.
Interval funds are a unique type of closed-end fund* that share some characteristics of open-end funds. Unlike typical closed-end funds, interval funds do not trade on the secondary market. In many ways, they operate like redeemable mutual funds: investors buy shares directly from the issuer at NAV, and a sales charge is often added on top of NAV.
*Although interval funds share many features with open-end funds, they are legally structured as closed-end management companies. Don’t focus on the legal details - focus on the category they fall into.
Investors can redeem shares later, but only at specific times. These scheduled redemption windows are called a repurchase offer. Most interval funds allow redemptions monthly, quarterly, semi-annually, or annually. For example, an interval fund with quarterly repurchase offers allows investors to redeem shares only four times per year. Outside those windows, investors generally can’t liquidate their shares.
Interval fund managers also limit how many shares they’ll redeem during each repurchase offer. In most cases, the fund won’t allow more than 25% of outstanding shares to be redeemed in any repurchase period. If investors request more redemptions than the fund is willing to repurchase, the fund typically allocates redemptions on a pro-rata basis.
For example, suppose two investors each request to redeem 10 shares (20 total), but the fund is only willing to repurchase 16 shares. Each investor would be allowed to redeem 8 shares.
Because of this structure, interval funds are known for liquidity risk. They may be unsuitable for investors who need quick, easy access to their money. Many interval funds also charge redemption fees (repurchase fees) of up to 2%. Relevant rules and regulations do not allow redemption fees above this amount.
Sales charges and redemption fees aren’t the only costs to consider. Interval funds are also known for high expense ratios (often due to significant management fees) and 12b-1 fees. In other words, investors can face multiple layers of costs.
So why would an investor consider an interval fund? The “lock-up” feature gives the fund manager more flexibility. Instead of managing daily redemptions (as open-end fund managers do) or dealing with investors selling shares in the market (as typical closed-end fund managers do), interval fund managers can count on assets staying in the fund for at least some period of time. That can allow the manager to invest in less liquid, higher-risk investments that may offer higher yields - without being forced to sell holdings to meet frequent redemptions.
If you want to see real-world examples, check out Pimco interval funds.
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