Closed-End funds

Closed-end funds are investment companies that issue a fixed number of shares in their initial public offering and then invest that capital in financial assets such as stocks, bonds, and other securities. This article overviews closed-end funds and will help you get the most out of them for your financial life.

Closed-end funds are professionally managed investments that offer many potential benefits to investors. Like open-end mutual funds and exchange-traded funds, closed-end funds provide access to broad diversification by investing in a variety of stocks, bonds, and other assets.

In addition, closed-end funds are generally actively managed by teams of investment professionals whose full-time jobs focus on tracking current holdings and seeking new opportunities. Investors can benefit from this active management, which can often add to returns by increasing the chances of outperformance relative to their market benchmark.

As of June 2021, the largest type of closed-end fund was the municipal bond fund, which invests in the debt obligations of state and local governments and federal government agencies. The managers of these funds seek broad diversification to minimize risk, but they may also rely on leverage to increase returns.

Investors in closed-end funds receive distribution payments on a regular basis, typically monthly or quarterly. These distributions come from three main sources: ordinary dividends, capital gains, and return of capital. Closed-end funds may use a managed distribution policy, which can help them to generate steady cash flow from distributions.

How Close-End Funds Work
Closed-End funds 1

How Close-End Funds Work?

Unlike mutual funds and ETFs, which are open to new investors at any time, closed-end funds only issue a fixed number of shares in an initial public offering or through secondary or follow-on offerings, at-the-market offerings, rights offerings, or dividend reinvestments.

The market price of a closed-end fund fluctuates throughout the trading day just as stocks do. The share prices of closed-end funds may trade at a premium or discount to their net asset value. The market establishes the discount or premium and reflects the buying and selling demand for the fund’s shares, which in turn are influenced by investor perceptions and concerns, as well as the need for specific types of investments.

Closed-end funds pay regular distributions to their shareholders, and as with other mutual funds and ETFs, investors must report these distributions on their tax returns. Each fund must provide IRS Form 1099-DIV annually to shareholders, detailing the source of each distribution payment. The sources of distributions typically include ordinary dividends, capital gains, and return of capital.

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