Advice for Investing in a Closed-End Fund
- Because of their structure, CEFs can be traded at a premium or at a discount to their net asset value (NAV). The NAV per share is established daily by adding up the market value of the fund's holdings and dividing by the number of shares outstanding. The fund's share price, on the other hand, is determined by supply and demand. There may be situations in which a fund's shares have a NAV per share of $20 and trade at $18--a 10 percent discount.
- Some funds trade several hundred thousand shares daily; others hardly trade at all. Stick with the most actively traded funds. If a fund is thinly traded, you may pay too much when buying and get too little when selling; you may also have difficulty selling at all in a rapidly declining market.
- Closed-end funds vary in size from several million to several hundred million dollars. The larger a fund, the more diversified it is, and the more clout it may have in the market when buying and selling securities.
- Some closed-end funds use leverage to enhance shareholder returns. Leverage can increase both gains and losses, making leveraged funds more aggressive and risky. A reasonable compromise may be to use a fund with limited leverage, for example not to exceed 25 percent.
- Most CEFs are designed to invest in specific segments of the stock or bond markets, such as junk bonds or single countries. These types of investments go in and out of favor with investors. A CEF with an outstanding three- or five-year record may not be able to repeat its performance in the next three or five years while another fund that is down 50 percent over the past three years may stage a strong rebound.
