A closed-end fund (CEF) is a publicly traded investment company. It collects money from investors through an initial public offering (IPO) and uses this money to invest in securities.
The shares of a CEF trade on market exchanges such as the New York Stock Exchange (NYSE).
A closed-end fund, as with any other incorporated public companies, has a board of directors elected by the shareholders. The board appoints an investment advisor (and, possibly, sub-advisors) for investment research and portfolio management.
The investment advisor employs a portfolio manager who is often assisted by a team of analysts and who makes the actual investment decisions, in accordance with the guidelines listed in the prospectus issued during the initial public offering and any amendments to it.
The day-to-day administrative duties such as mailing shareholder reports or responding to shareholder concerns may be performed by the investment advisor, or a separate administrator may be employed.
CEFs offer a wide array of investment choices for the investor. There are: Diversified Domestic Funds, Sector Funds, Single Country Funds, Regional Funds, Emerging Markets, Global Funds and etc.
The net asset value (NAV) of a CEF is the current worth of a share of the CEF. It is computed by deducting the total assets of the CEF (the current market value of the securities held by the CEF plus cash) from the total liabilities, and dividing the result by the total number of outstanding shares.
NAV = (Total Assets - Total Liabilities) /
The NAV of a CEF will fluctuate with the changes to the market price of the securities in which the CEF has invested.
CEFs are publicly traded, that is, the shares of the CEF change hands in stock exchanges. The price at which the shares trade is called the market price. The market price of a CEF will fluctuate with the demand and supply principles of the market.
Sometimes, when demand exceeds supply, the market price at which the shares of a CEF trade may be at a premium to the NAV, that is, the shares of the CEF cost more than its NAV.
Likewise, when supply exceeds demand, the shares of the CEF may trade at a discount to its NAV, that is, the shares of the CEF cost less than its NAV.
For example, if the NAV of a CEF is 10 and its market price is 12, the CEF is trading at a premium of 20%. If the NAV is 10 and its market price is 8, the CEF is trading at a discount of 20%.
The premium/discount may be computed using the following formula:
Premium/Discount = (Market Price - NAV) / NAV
Though some funds trade at a premium, the majority of CEFs trade at a discount, often as much as 15%-20%. The premium or discount is not constant, but usually fluctuates with market conditions.
Often a fund that is trading at a discount may shoot upto a steep premium or vice versa, as investors perceptions of the market changes.