Closed End FundsMutual Funds
Closed end funds are not purchased or sold from the fund itself. These funds trade on share exchanges, so the fund managers do not have to issue or redeem shares on a regular basis. They issue shares at the beginning of the fund via an initial public offering. Once the initial desired amount of shares has been sold to the first investors, the fund managers use the finances raised to purchase the fund’s investment instruments. After this point the shares are traded openly between investors, and the fund managers will not sell additional shares. Management will only redeem shares if the fund is dissolving by selling all assets and distributing proceeds to all investors holding shares at the time. Investors who want to exit the firm must sell their shares on the open market.
Closed End Funds: Dynamics Differences
Closed funds have drastically different dynamics compared to open funds. Close end funds don’t trade at their net asset value. They trade based on supply and demand. If they are in high demand they will trade at a premium to their value, if in low demand they will trade at a discount. Closed end funds rarely trade exactly at their net asset value. This also adjusts the way you receive your return: Increases in NAV will not determine your profit since the fund’s price is tied to demand. Returns must be accompanied with increased demand to be profitable. With an open end fund, the increase in net asset value alone determines your return. To increase returns buying funds at a discount to NAV is preferable if possible, but you must be aware of the reason for its pricing. If the discount disappears and the fund returns to net asset value, you have already gained the difference as profit.
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