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An Introduction to Closed-End Mutual Funds

One of the investment universes that Five Seasons Financial Planning monitors in an ongoing search for value to exploit for the benefit of client portfolios is that of closed-end mutual funds.  Closed-end funds (CEF's) often fly under the radar of larger investment managers and wealth management firms who use cookie-cutter model portfolios.  But at this time of year, when tax-loss selling is prevalent, there are often compelling values to be found in the CEF universe, and this year is no different.


We've taken this opportunity to add a few new CEF positions to client portfolios recently, taxable bond funds into tax-qualified accounts and municipal bond funds into taxable accounts.  And there are several other funds currently on our radar screen.  Since you may be somewhat less familiar with the concept of closed-end mutual funds than with other types of mutual funds, here's a quick primer:


* Like many of the more common open-ended mutual funds, CEF's are actively managed.  That is, closed-end funds are managed by a portfolio manager, or team of them, and aided by analysts, they attempt to maximize fund returns subject to a given investment objective, or in comparison to a given benchmark.


* Like other types of mutual funds, whether they be open-ended funds, index funds, or exchange-traded funds (ETF's), each closed-end fund also has a "net asset value" that is updated and made public daily.  A fund's net asset value or NAV is simply the up-to-date total market value of all its holdings divided by the number of shares of the fund outstanding.  Net Asset Value can be thought of as the intrinsic value of each mutual fund share.


* Unlike these other types of mutual funds, however, closed-end funds have a fixed number of shares outstanding.  And unless you buy CEF shares at their initial public offering, you must buy or sell them on a stock exchange, rather than relying on the mutual fund company to be your counter-party.


* Since closed-end funds are traded between investors on stock exchanges, rather than being issued to, and redeemed from, investors by the mutual fund company itself, market prices of CEF's can and do differ dramatically from their net asset values.  


In addition, there are some other, more technical, differences between closed-end funds and other types of mutual funds, e.g. the use of leverage, the variability of dividend policies, and liquidity concerns, that call for due diligence.  However, it's really the ability to be able to buy closed-end funds at substantial discounts to their NAV's, or intrinsic values, that make them an enticing way to add value to, or to generate income from, a diversified portfolio.