31 – L1 30 ClosedEnd Mutual Funds V3

Because the need to maintain cash tends to erode the total return of the open-end fund, the financial services industry created closed-end funds to address this issue. Closed-end mutual funds are closed ended because they accept investor money when the fund is initially created and don’t create new shares or handled withdrawals afterwards. By making the fund closed ended, the portfolio managers no longer have to keep cash on hand and no longer have to liquidate existing positions to satisfy redemption requests. This also means that money managers can use all of the cash towards their investment strategies, potentially improving the overall return of the fund. So, what do investors do if they wish to stop investing in the fund and get their cash back? Investors can sell their shares to other investors. For investors, shares of closed-end funds can be bought and sold on the stock exchange just like a stock. This means that investors do not need to wait for the mutual fund to process their share redemption. However, the price of closed-end funds is determined by the supply and demand of that funds shares on an exchange, and often will not precisely reflect the fair market value of its underlying portfolio. In other words, closed-end funds often trade at a discount or premium to the net asset value other underlying holdings. In a later lesson, we’ll see how exchange traded funds are designed to improve upon both open-end and closed-end funds.

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