Closed-End Funds as a Vehicle for Alternative Investments Montrose CO

As investors have sought to diversify their portfolios with alternative assets, some have turned to closed-end funds (CEFs) as a vehicle for these investments. As is true with most investment opportunities, these funds offer some advantages and pose some risks for individual investors.

Closed-end funds generally raise money for investing only at inception, offering a fixed number of shares in an initial public offering (IPO). Unlike mutual funds, they do not continue to take in money to invest after the initial shares are sold, and as a general rule they don’t redeem shares or buy them back from investors.

Shareholders who want to cash in their CEF investments must sell them, and to facilitate this market, most closed-end funds are traded on a securities exchange. The price at which each fund trades is based not only on the net asset value (NAV) of its investments but also on the supply and demand for its shares in the marketplace. As a general rule, closed-end funds sell at a premium (for more than NAV) when first issued to cover expenses of setting up the fund and then at a discount once the initial shares are sold. In contrast, the market prices of other exchange-traded funds (ETFs) – most of which are index funds – generally track their net asset values pretty closely, according to Morningstar.com.

According to the Closed-End Fund Association ( www.cefa.com ), investors have more than 500 CEFs to choose from. While the majority of these funds invest in tax-exempt bonds, many of the taxable funds focus on specific sectors that are considered alternative investments. A few of today’s funds have been around since the Great Depression, and some investors have held their shares for decades and passed them down through the generations. However, most CEFs now on the market were set up after 1990.

Closed-end funds pay distributions to investors on a regular schedule, and the pay-outs of many funds are closer to those of debt instruments than to equities. Unlike most bonds, however, closed-end funds tend to make distributions more frequently, on a set monthly or quarterly schedule. CEFs’ distribution histories are also factored into their selling prices as investors recognize the benefit of a steady cash-flow from them.

Because CEFs have a set number of shares, managers don’t have to sell assets to meet withdrawal demands or buy assets to meet targets when new deposits come in. However, the fluctuation in NAV poses a risk that investors will lose money if the discount increases after they purchase shares.

Lower Turnover, Lower Expense Ratios

According to Rebecca Schreiber, CFP®, a fee-only financial planner with Solid Ground Financial Planning in Silver Spring, Md., closed-end funds tend to have low expense ratios, and this makes them popular with young investors who are “very interested in growth in their retirement accounts and also sensitive to costs – they want to make sure t...

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