Closed End ETF

By: EconomyWatch   Date: 3 August 2009

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 A closed end ETF or CEF is an investment option that is traded in different exchanges. Closed end ETFs invest in a variety of securities. They raise capital through IPOs (initial public offerings). The collected funds are then invested as per the ETF’s investment objectives.

 

The term ‘closed end’ signifies that the stocks of these ETFs are limited in number. Once the required fund is raised, no more stocks are issued. Hence, such funds are ‘closed’ for new traders. Closed end ETFs or CEFs have a board of directors that appoints a portfolio manager and an investment advisor for supervising the progress of the ETFs.

 

Closed End ETFs Trading
 

These ETFs are listed on all the major national exchanges and are traded similar to other ETFs or stocks. The only difference between them and mutual funds or standard ETFs is the number of their stocks. Additional shares can be created, however, through secondary offerings or other financial activities. 

 

Differences between Closed End ETFs and Open End Funds 

Besides the intra-day tradability of ETFs, there are other differences between closed end ETFs and open end funds, such as:

  • The prices of closed end ETFs are determined by their demand, rather than by their underlying assets. This is unlike the traditional open end funds that are issued and redeemed directly on the basis of the value of their underlying assets.

  • Closed end ETFs maintain a fixed number of stocks throughout, whereas the number of shares of an open end fund keeps increasing with investments by traders.

 

Advantages of Closed End ETFs

 

Closed end ETFs have the following advantages:

  • Price and Trade Control: Closed end ETFs are bought and sold like stocks. Features like limit stops and stop order can be exercise with them, just like with normal stocks.

  • Good portfolio management: Being constant in its number of stocks, closed end ETFs are effectively managed and have higher profit potential in the longer term. 

Disadvantages of Closed End ETFs
 

The disadvantages of closed end ETFs are:

  • Credit risk: As many closed end ETFs invest in bonds, an interruption in the payment may create an imbalance in the payment structure.

  • Pricing risk: As the prices are based on the demand for the closed end ETFs, lower demand may mean selling ETFs at discounted prices.

 

Closed end ETFs are a good option for investors who wish to have low risk and prefer the buy and hold strategy.

 

 


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