Closed end funds are created by a fund manager that advertises the company to clients providing them the option of exclusive membership. Clients are generally large investors with huge portfolios. The pooling of large portfolios in a fund provides the fund manager with a lot of leverage when buying and selling stocks and negotiating preferential stock prices. Although these funds are characterized by flexibility on the part of the manager, all investments must be in line with the fund charter signed by all the stock holders.
Because they are so exclusive they are very different in style and form to the well known mutual funds. Mutual funds are open to practically anybody with some savings to invest, while closed end funds are limited to big investors. Managers have a lot of autonomy when investing which allows them to maximize their buying and selling power with quick decision making. Trust between the management and the clients is vital when dealing with such large investments.
The American SEC, or securities exchange commission consider closed end companies one of the three investment companies that are licensed to manage trusts and funds. What makes closed end companies somewhat different is that they are traded on the stock market, unlike mutual funds which are bought directly from the fund.
The fact that, as mentioned above stocks in closed end fund companies are traded on the stock market and not directly with the fund as with other investment options makes them a sort of in-house stock that is both flexible and somewhat independent from the market as a whole. We must remember that these funds are designed for the mid to long term and not for quick sale speculators.
Because of this, these companies can be traded with at any time during the day and not only at the end of the market day. Trading in these funds is therefore faster and more flexible than with other funds.
The value of a closed fund company is worked out differently to other funds also. While in typical funds the value is dependent nearly exclusively on the value of its assets and the sales charge in closed end funds it also depends on another factor, the premium or discount that the market places on the stock. All that is meant by premium or discount is the difference between the real value of the company’s assets and the stock price. When the difference is positive we refer to it as premium when negative it is a discount.
One of the fortes of these companies is that they have a lot of financial leverage. They can force themselves on brokers and investment opportunities with the weight of the huge portfolios that back them.
The particular features that make these funds unique create a special way of measuring the value and price of their stocks. As mentioned above the value is not solely dependent on net value but also on perceived value, the premium, or its evil twin, a discount, when the difference between the net assets value and the market price is negative. Interestingly, the value of shares in closed end funds is generally lower than the total assets of the fund. This might make it look as a perfect investment, and many investors would agree with you. There are only two problems, you must have enough money to join the exclusive clubs that form closed end funds and also be happy with not liquidating your stocks until the fund does. If you liquidate early you might be forced to sell at a loss.
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