Other Definitions
closed end fund (dict)
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Closed-end FundA Closed-End fund is one with a limited number of shares. No new shares are issued after the fund is launched. An investor can purchase shares in a closed-end fund from a broker. The price of a closed-end fund is determined by the premium (or discount) placed on it by the market. The value of the securities in the fund divided by shares in the fund, is called NAV for net asset value. The premium or discount means that the market price is above (premium) or below (discount) the NAV. ETFs, or exchange-traded funds, make up a subset of closed-end funds. Closed-end funds (also called closed-end mutual funds) are an interesting variety of mutual fund. Like normal mutual funds, closed-end funds pool investor money and put it under the control of a portoflio manager who then invests that money. What exactly the fund manger can invest in depends on the fund's charter. Some funds invest in stocks, others in bonds, and some in very specific things like tax-free bonds issued by the state of Florida in the USA. Distinguishments The two things that distinguish a closed-end fund from an ordinary mutual fund are that (1) it's closed to new capital after it begins operating, and (2) its shares trade on stock exchanges rather than being redeemed directly by the fund. Initial offering That is, a closed-end fund will have an initial public offering of its shares at which it will, say, sell 10 million shares for $10 each. That will raise $100 million for the fund manager to invest. At that point, however, the fund's 10 million shares will begin to trade on a secondary market, typically the NYSE or the AMEX for American closed-end funds. Any investor who wishes to buy are sell fund shares at that point will have to do so on the secondary market. Closed-end funds do not redeem their own shares. Nor, typically, do they sell more shares after the IPO. Exchange traded The fact that closed-end fund shares trade on stock exchanges leads to some very interesting pricing behavior. In particular, fund shares often trade at what look to be really irrational prices because secondary market prices are often very much out of line with underlying portfolio values. Discount For instance, US closed-end stock funds have share prices are typically about 10% less than per-share portfolio values. That is, if a fund has 10 million shares outstanding and if its portfolio is worth $200 million, then each shares should be worth $20 and you would expect that the market price of the fund's shares on the secondary market would be around $20. But, very oddly, that's typically not the case. The shares may trade for only $18 or even only $16. In the former case, the fund would be said to be "trading at a 10% discount to Net Asset Value," where Net Asset Value (NAV) is simply the fund's total assets minues total liabilities. In the later case, the fund would be said to be trading at a 20% discount to NAV. Premium Even stranger, funds very often trade at substantial premiums to NAV. Some of these premia are extreme, with premia of several hundred percent having been seen on occasion. Why anyone would pay $30 per share for a fund whose portfolio value per share is only $10 is not well understood, although irrational exhuberance has been mentioned. The presence of discounts is also puzzling since if a fund is trading at a discount, you would presume that a rich investor would come along and buy up all the fund's shares at a discount in order to gain control of the portfolio and liquidate it at its (higher) market value. A great deal of academic ink has been spent trying to explain why closed-end fund share prices aren't forced by arbitraguers to be equal to underlying portfolio values. Though there are many strong opinions, the jury is still out. Examples Currently, the two most popular US CEFs (which also happen to be ETFs) are the S&P Depository Receipts (AMEX:SPY), and the NASDAQ 100 Trust units (NASDAQ:QQQQ), each trading over 40 million shares a day. The first is a proxy for the S&P 500 index, and the second for the NASDAQ 100 index. See also External links *Closed-End Fund List
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