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 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 initially 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.
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 a net asset value (NAV). In both cases, NAV reflects the total value of the portfolio’s assets (net of liabilities) on a per-share basis. For closed-end funds, NAV is not the transaction price. Instead, it serves as a reference point for the fund’s market price.
Because closed-end shares trade in the secondary market, their price moves with supply and demand. If demand increases, the market price can rise even if the NAV doesn’t change. If many investors sell, the market price can fall even if the NAV doesn’t change.
You can think of NAV for a closed-end fund the way you might think of Kelley Blue Book 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. Strong demand could push the price above $10,000; weak demand could push it below. Closed-end fund NAV works the same way: it’s a “book value” reference, while the market sets the trading price.
The market price for a closed-end fund can be higher than, lower than, or equal to NAV. Ultimately, market demand determines the trading price. This differs from open-end funds, where investors buy and redeem shares at NAV (and, if applicable, sales charges are added on top).
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 in the secondary market. In many ways, they operate like redeemable mutual funds: investors buy shares directly from the issuer at NAV. Often, a sales charge is added on top of NAV.
*Although interval funds function in several ways like open-end funds, they are legally structured as closed-end management companies. Don’t get stuck on the mechanics here - 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 repurchases monthly, quarterly, semi-annually, or annually. For example, an interval fund with quarterly repurchase offers would allow redemptions 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 repurchase 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 will repurchase only 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 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 cost concerns. Interval funds are also known for high expense ratios (often driven by management fees) and 12b-1 fees. Bottom line: interval funds can involve multiple layers of costs.
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 count on assets staying in the fund between repurchase offers. That stability can allow the manager 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 want to see real-world examples, check out Pimco interval funds.
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