Description

This article is from the A Guide to Closed-End Funds (CEFs).

Major Differences between CEFs and Mutual Funds

CEFs differ from mutual funds in three major respects:

1. the buying and selling of the funds' shares,
2. the price at which shares are bought and sold, and
3. the fees and commissions charged for buying, selling, managing and operating the funds.

These differences impact the performance of the investment advisor, the opportunities for the individual investor to limit risk and increase profit, and the costs incurred in investing in the funds.

In more detail, the three major differences between the CEFs and mutual funds are:

Buying/Selling Shares .

When an investor wishes to buy shares in a mutual fund, the fund issues him new shares. Similarly, when an investor wishes to sell shares in a mutual fund, the fund redeems his shares. The number of outstanding shares of a mutual fund is constantly changing (and, hence, the pool of investment money is also constantly changing) due to these issuances and redemptions. However, when an investor wishes to buy or sell shares of a CEF, he must find another investor who wishes to sell his shares or buy shares from him. Normally, the investor approaches a broker who places his order on an exchange in which the CEF is traded, and waits until the order is executed. The pool of money collected by the CEF for investment remains constant after the initial public offering (except in relatively rare cases such as secondary offerings, rights offerings, or issuance of shares for dividend reinvestment.)

Price.

The price at which an investor buys or sells shares of a mutual fund is the net asset value (NAV) as determined by the fund company at the close of the business day (or, in some cases such as the Fidelity Select funds, at the close of each business hour). The investor has little control over the price he pays for the shares. However, the price at which an investor buys or sell shares of a CEF is the market price as determined by the demand and supply market principles. For example, if many investors wish to buy shares of a CEF and few shares are available for sale, an investor may be able to sell the CEF at a premium to the NAV. Accordingly, the investor has control over what price he pays for the shares of the CEF.

Fees and commissions.

A mutual fund investor, depending on whether the fund is no-load or load, may pay a commission to buy and sell shares of the mutual fund. In addition, the investor pays fees to the fund company for managing and administering the fund. Similarly, a CEF investor pays a commission to a broker to buy or sell shares, and a fee to the fund company to manage and operate the fund.

Though these differences may seem superficial, they are instrumental in providing investors in CEFs some critical advantages over investors in mutual funds.

Advantages of CEFs Over Mutual Funds

For simplicity, we structure these advantages under two of the major differences discussed above: stability of the pool of investment money and control over the price of the funds' shares.

 

Continue to:

• prev: Closed-End Funds and Mutual Funds
• Index
• next: Stability of the pool of investment money.

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