Your Money: Closed-end funds: diversification with a difference

Your Money: Closed-end funds: diversification with a difference

By Juergen Selk

By Juergen Selk

Financial Consultant

Closed-end funds: diversification with a difference

Savvy individuals have long recognized the many advantages of investing in mutual funds–diversification, professional portfolio management, and the chance to participate in markets that may otherwise be inaccessible. What many don’t know is that there is another, similar investment that offers all this with important additional benefits–closed-end funds.

• What are closed-end funds?

Closed-end funds, or CEFs, are pooled investment portfolios that differ from mutual funds primarily in the way their shares are sold to investors.

In a mutual fund, when shares are purchased, the money goes directly to the investment advisor, and new shares are created and issued at Net Asset Value (NAV). When those shares are sold, they are redeemed by the advisor at NAV, and the shares no longer exist. Closed-end funds differ in that, after an initial public offering, the fund is closed, and generally no new shares are issued. The fund’s shares then trade on an exchange or over the counter, just like the common stock of a corporation. As a consequence, the shares of a CEF may trade above (at a premium to) or below (at a discount to) their NAV, subject to supply and demand.

• What’s so special about closed-end funds?

Closed-end funds offer investors a professionally managed, diversified portfolio of securities with no minimum investment requirement. And CEFs can sometimes be purchased at discounts to NAT, giving them another potential means of appreciation, compared with the identical portfolio purchased at NAV. With discounts, they can also yield more than their counterparts.

In addition, many fixed-income closed-end funds boost yields through the use of leverage. In its simplest form, leverage is borrowing at short-term rates in investing those assets at long-term rates to capture the typical spread between the two. For investors who wish to increase yield and are willing to take on additional risk, leveraged funds may make sense.

There are many varieties of closed-end funds, including stock, bond and balanced funds; funds for income or growth; and funds that provide exposure to an investment sector or a geographic region. CEFs can even gain you access to investments that are ordinarily out of reach of the individual investor, including certain restricted stock markets and some illiquid investments, such as private placements and venture capital.

Juergen Selk is a financial consultant at Salomon Smith Barney in Rockford. Salomon Smith Barney does not offer tax or legal advice. If you have an investment or finance-related question, send it to The Rock River Times or to!

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