Closed end funds are generated by a fund manager who promotes the company to clients offering them the option of exclusive membership. Clients are basically big players with magnificent portfolios. The amalgamation of great portfolios in a fund offers the fund manager a lot of option when buying and selling stocks and negotiating related stock prices. Although these funds are flexible on the part of the manager, all investments should be in sequel with the fund documents signed by all the stock bearers.
Features of Closed End Fund
- Their exclusiveness makes them very unique in style and form to the popular mutual funds.
- Mutual funds are open to generally anybody with some funds to invest, while closed end funds are restricted to big investors.
- Trust between the client and the management plays a vital role when such large investments are involved.
- The American securities exchange commission considers such closed end companies as one of the three investment organizations that are licensed to organize trusts and funds.
- What makes closed end companies unique is that they are facilitating stock market for trading, unlike mutual funds which are received from the fund directly.
- As stocks in closed end fund companies are traded using the stock market instead of directly with the fund it makes them a kind of in-house stock that is flexible and somewhat separate from the market in totality.
- These funds are crafted for the mid to long term trading and not for fast sale speculators.
- Because of this reason trading with these companies can be done any time during the day instead of at the end of the market day.
- Trading in these funds is hence rapid and more flexible than with any other fund.
- The specific features that make these funds unique is to generate a specific way of measuring the value and cost of their stocks.
- As said the value is not only dependent on net value but also on estimated value; its evil twin, premium, or a discount, when the difference between the market price and net assets value is negative.
- Interestingly, the value of shares is often lower in closed end fund than the total cost of the fund.
- This might manifest it as a perfect investment, and many investors would accept it also.
Requisites for Closed End Funds
The two requisites are - enough money to join the exclusive clubs that create closed end funds and, be comfortable with not liquidating your stocks so long the funds are not liquidated. If you want to get cash early you might be compelled to sell at a loss.
How it Functions
- Closed-end funds issue a limited number of shares which are mentioned there on a stock exchange.
- They are professionally organized investment organizations.
- Once issued, the fund is not available for buying and selling of the shares.
- The shareholders become the owner of these shares.
- Within certain legal parameters, they are allowed to issue one section of preferred shares.
- Preferred shares yield regular dividends immediately and they do not share in the profits and losses.
- The issue of preferred shares allows it to procure additional fund that it can facilitate to buy more securities for consolidating its portfolio.
- This is termed as "leveraging."
- This will lead to higher returns for the normal shareholders.
- Another type of financial operation that is possible is, borrowing money or offering debt securities.
- This is apparently done to invest the extra fund raised in securities that are there to earn higher dividends.
Management of Closed End Funds
- Leveraging is so common practice that 71 percent of closed-end funds harbored this practice in 2007.
- The laws are created to protect investors from abuse and fraud of authority.
- The management is monitored by a board of directors elected jointly by the shareholders.
- They look after the daily business affairs and monitor fund's interests, ipso facto, the interests of the shareholders etc.
Benefits to Shareholders
- The shareholders also get several structural benefits.
- There is no necessity to maintain cash position.
- The fixed asset enables leveraging programs.
- You can avail the opportunities to purchase assets at a discount to their net asset value.
- The process to procure funds is identical to that of a company that is open to public; in these circumstances a limited number of shares are offered at a preset price.
- Thereafter the shares are traded in the normal course of business in the exchange.
- But the assets are being supervised by a fund manager.
- Low or no cash situation has advantages, as the company stops accepting new capital from investors and the shares of the current customers are not paid.
- This means the invested capital remains intact within the investment paradigms.
- The net return would be higher if maintaining cash reserve is not necessary to meet the redemptions.
Any financial company requires perfect management. If recklessness is displayed in this area, it will affect the chain of results. Some of the reasons of doing funds trading at discounts include lack of advertising and research, incurring losses through dividend reductions, and the mood of the common investors. The prudent shareholders can turn the table of this trend by sending across right signals to the management and by taking right corrective measures.