Closed-end management companies

Closed-end management companies are similar to open-end management companies. Both invest pools of money according to each fund’s objectives in hopes of investment returns. However, open and closed-end management companies are capitalized (structured) and transacted differently.

Commonly referred to as closed-end funds, these pooled investments are initially offered to investors in the primary market, then are traded in the secondary market. This is how most securities are transacted (on a negotiable basis), including common stock and debt securities. Unlike mutual funds, closed-end funds are not subject to sales charges (loads). Instead, transactions are subject to commissions. Also, closed-end funds can be purchased on margin (with 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 on the issuer and the security being sold. After the primary market offering, the issuer focuses solely on running the fund. Like mutual funds, the fund manager’s goal is to manage assets to maximize their investor’s return.

*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 maintain net asset values (NAVs). In both circumstances, the NAV reflects the overall value of the assets held in the portfolio. However, it is not necessarily the basis for transaction pricing. The NAV only serves as a guide for its market price. Closed-end shares trade in the secondary market and are subject to price fluctuations based on demand. If there is an influx of purchases for a closed-end fund, the price will rise even if the NAV does not. Conversely, if there are significant liquidations (sales), the price will fall even if the NAV does not.

NAVs for closed-end funds act just like Kelley Blue Book does for cars. Let’s say you plan on selling your car and find it listed for $10,000 in Kelley Blue Book. Your car may have a “book value” of $10,000, but the market will ultimately determine how much you sell it for. If there’s more demand for your car, you could sell it for more than $10,000, and vice versa. NAV works the same way with a publicly traded fund.

The market price for a closed-end fund can be higher, lower, or the same as the NAV. In the end, the demand in the market will determine its price. Remember, this differs from open-end funds as the NAV is the minimum price an investor will pay for mutual fund shares.