Closed-End Fund FAQ's

What is a closed-end Fund?

Like a traditional mutual fund, a closed-end fund is an investment company that pools the assets of its investors and uses professional managers to invest the money to meet clearly identified objectives, such as current income or capital appreciation. However, unlike a mutual fund, a closed-end fund issues a fixed number of shares through an initial public offering, and lists those shares on a national stock exchange such as the New York Stock Exchange (NYSE). Investors who wish to buy or sell fund shares do not purchase or redeem directly from the fund - rather, they buy or sell fund shares on the stock exchange in a process identical to the purchase or sale of any other listed stock.

Is a closed-end fund closed to new investors?

No. Although closed-end funds have a fixed number of shares outstanding, investors can purchase and sell shares in closed-end funds at any time during the trading day, similar to any other listed security.

What is the portfolio composition of these funds?

The specific securities that closed-End Funds hold depends on the portfolio manager and the investment objectives of the fund, and can range from a concentrated portfolio of just a few securities, to a diversified portfolio of several hundred holdings. Most fund sponsors make detailed portfolio holdings available each month or each quarter.

What is leverage and how is it used?

Leverage is a strategy of borrowing at short-term rates to buy additional investments, seeking a beneficial difference between the total return of the additional investments and the cost of borrowing. closed-end funds leverage themselves through issuing equity (preferred shares) at short-term rates, borrowing or issuing debts, or holding leveraged securities in the fund's portfolio. See Understanding Leverage.

Are dividends paid by closed-end funds?

Closed-end funds may distribute their earnings to shareholders in two ways. First, income dividends from interest or stock dividends are passed through to shareholders, net of expenses. Second, realized capital gains (net of realized capital losses) distributions are passed through to shareholders (typically once a year in November or December).

Closed-end funds also may have managed distribution programs. A managed distribution program permits a fund to pay realized capital gains and/or a return of capital more than once per year. The goal of a fund’s managed distribution program is to provide shareholders relatively consistent and predictable cash flow, by systematically converting its expected long-term return potential into regular distributions. As a result, regular distributions throughout the year will likely include a portion of expected long-term and/or short-term gains (both realized and unrealized), along with net investment income. The fund must communicate its estimate of the components of a managed distribution with each payment.

How do I buy/sell closed-end funds?

Like mutual funds and stocks, closed-end funds may be purchased in regular brokerage accounts (individual or joint-name), retirement plan accounts, trust accounts or custodial accounts. Closed-end funds can be purchased and sold on national exchanges just like any other stock. All the strategies associated with stocks, such as market orders, limit orders, stop orders, short sales, and margin buying can be used in the purchase and sale of closed-end funds, according to the policies of the account or broker-dealer firm holding that account.

Can an investor make money by buying funds selling at a discount?

Since there is no guarantee that funds trading at a discount will ever trade at their net asset value, there is no guarantee that the investor can make money by purchasing shares trading at a discount and hoping for that discount to disappear. Similarly, there is no guarantee that funds trading at a premium will continue to trade at a premium. Market prices for closed-end funds are established through supply and demand, and shares frequently trade at both premiums and discounts to their net asset values.

Is there a sales charge associated with purchasing shares?

No. Because closed-end funds trade on national exchanges similar to stocks, there is no sales charge attributed to the transaction, although your broker will charge a commission for the purchase or sale of fund shares.

How can I hold my closed-end fund?

Investors can hold closed-end funds in book entry or in certificate form. If you hold the shares in book-entry, your broker maintains the records for the shares, and you may transact in those shares without providing any paper certificates. In certificate form, a physical certificate is mailed to the investor, and any transactions associated with fund shares must be accompanied by the certificate.

What is an automatic dividend reinvestment plan?

Typically, shareholders can choose to receive any dividends distributed by the closed-end fund in cash, or use the dividends to purchase additional fund shares. An automatic dividend reinvestment plan automatically invests all dividends received by investors in additional fund shares.

How are closed-end funds taxed?

As an investment company registered under the Investment Company Act of 1940, a closed-end fund passes through taxes to its shareholders, based on the fund's income, expenses, gains, and losses, as long as the fund complies with certain regulations. Fund shareholders typically receive a 1099-DIV statement from the fund (through a broker-dealer) after the end of each calendar year, itemizing the amount and characterization of any distributions received from the fund during the year. In certain special circumstances, shareholders may also receive other tax forms related to retained capital gains or partnerships. Please consult your tax advisor for information related to your specific tax situation.

Can closed-end funds go out of business?

Because closed-end funds are established as investment companies, they are prohibited from engaging in any activity that is not of an investment nature. Technically, a closed-end fund could go out of business if all the securities in its portfolio become worthless. The fund's shareholders could also vote to merge fund shares or to liquidate the fund’s investments and distribute the proceeds to shareholders, or to convert a closed-end fund to an open-end fund. This would generally occur only on the recommendation of the fund’s Board of Directors, who would have to conclude that such an action or actions are in the best interests of all shareholders.

This information should not be construed as specific tax, legal, or investment advice. References to any specific securities do not constitute an offer to buy or sell securities.

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