Closed-end management companies are similar to open-end management companies in what they do: both pool investor money and invest according to the fund’s stated objectives in pursuit of returns. The key difference is how investors buy and sell shares.
Closed-end funds trade between investors in the secondary market, not directly with the issuer. When an issuer creates a closed-end management company, it prepares a prospectus and sells shares through an initial public offering (IPO). After the IPO is complete and the issuer has received the proceeds, the shares begin trading in the secondary market. Because investors can transfer ownership in the market, closed-end fund shares are negotiable securities.
Like most negotiable securities, closed-end funds have a fixed (closed-ended) number of shares outstanding that trade in the secondary market. This is a different type of capitalization than open-end (mutual) funds, which continuously issue and redeem shares and therefore have a changing number of shares outstanding.
During the IPO, the prospectus rule applies. Every purchaser must receive a prospectus, which provides detailed information about the issuer and the security being sold. After the IPO shares have been sold, prospectus delivery is no longer required.
Closed-end funds don’t have sales charges because investors aren’t buying shares from the fund itself. Instead, shares trade in the secondary market and transactions are subject to commissions (similar to stocks and bonds). On exam questions, this distinction is often tested: mutual funds may have sales charges, while closed-end funds are subject to commissions.
Because closed-end funds trade in the secondary market, they can be purchased on margin (using borrowed money) and sold short. Stocks and bonds can also be purchased on margin and sold short, while mutual funds cannot.
Closed-end funds calculate net asset value (NAV) just like mutual funds. In both cases, NAV reflects the value of the assets held in the portfolio. The difference is how NAV is used.
For a mutual fund, NAV is the foundation for the transaction price. As covered in the previous chapter:
So, the lowest price a mutual fund share can be purchased for is its NAV.
For a closed-end fund, NAV is not the transaction price. Instead, NAV serves as a reference point (a “book value”) for the fund’s market price. Since shares trade in the secondary market, the price moves based on supply and demand. That means:
A helpful comparison is Kelley Blue Book for cars. A car may have a “book value” of $10,000, but the actual selling price depends on what buyers are willing to pay. Closed-end fund NAV works the same way: it’s a benchmark, while the market sets the price.
As a result, a closed-end fund’s market price can be higher than, lower than, or equal to its NAV.
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. Instead, investors purchase shares directly from the issuer at NAV. Often, a sales charge is added on top of NAV.
*Although interval funds behave like open-end funds in several ways, they are legally structured as closed-end management companies. The key point to remember is the category of investment company they fall into.
Investors can redeem shares later, but only at “specific intervals.” 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 redemptions 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 will redeem during each repurchase period. In most cases, the fund won’t allow more than 25% of outstanding shares to be redeemed at any repurchase offer. If investors request more redemptions than the fund is willing to repurchase, the fund typically fulfills requests on a pro-rata basis. For example, if two investors each request to redeem 10 shares (20 total) but the fund will repurchase only 16 shares, each investor would be allowed to redeem 8 shares.
Because of this structure, interval funds carry meaningful liquidity risk. They’re generally unsuitable for investors who need quick, easy access to their money. Many interval funds also charge redemption fees (repurchase fees) of up to 2%. 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 driven by significant management fees) and 12b-1 fees. Bottom line: investors may face multiple layers of costs when investing in interval funds.
Given the risks and costs, why might 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 plan around scheduled repurchase periods. This can make it easier to invest in less liquid, higher-risk investments that may offer higher yields. As always, an investor needs to weigh potential returns against the fund’s costs and risks to decide whether it fits their portfolio.
If you’re curious and want to study a few real-world versions of this type of fund, check out Pimco interval funds.
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