Pricing

When buying or selling either an open-end or closed-end fund, an investor usually knows the current value of the fund’s assets per share (NAV).

For example, to buy an open-end fund with a NAV of $15, an investor pays $15 per share. The fund simply issues new shares to the investor at the current NAV. The assets the fund manages have increased, but the value per share remains the same because the new shares have exactly the same value as the other shares. If the investor sells, he or she is paid the NAV. The amount of assets the fund manages has been reduced, but the NAV of outstanding shares has not changed because the shares redeemed were equal in value to all others.

With closed-end funds, the shares are traded in the open market and are consequently subject to demand/supply imbalances. They may trade at a price greater than their NAV (termed a premium) or at a price below the NAV (termed a discount).

FundsFor example, if the NAV is $15 and the closed-end fund’s stock is selling at 161/2 ($1.50 above the NAV), the fund would be trading at a 10-percent premium. That is, the stock price is 10 percent greater than the NAV. Conversely, if the closed-end fund’s stock is selling at 131/2 with a NAV of 15, the shares would have a 10-percent discount. That is, they would be trading at 10 percent below the NAV.

With the exception of some dual-purpose funds and a few specialty funds, almost all closed-end funds have at some time sold at discounts to NAV. The weekly listing of closed-end funds in many major financial publications often includes the percentage differential (premium or discount) between the closed-end fund’s current market price and NAV. Such data is easily accessible.

We can now begin to see why closed-end funds can provide advantages. When selling at a discount, the investor is able to purchase assets below their portfolio’s underlying market valuation. In addition, the premium/discount can vary with changing market conditions and shifts in investor sentiment. When the market is overpriced and optimism prevails, premiurns tend to increase and discounts narrow. When the market is depressed and pessimism dominates, premiums tend to fall and discounts widen.

Costs

Both open- and closed-end funds have both management and administrative fees. They also bear transaction costs associated with the fund’s buying and selling of securities.

Fund expenses aside, the investor also has some costs. Open-end funds may require a sales charge (termed the load), which the investor must pay when buying shares in the fund, or they may not have a sales charge (termed a no-load). In addition, open-end funds may charge the investor a redemption fee, that is, a charge when the shares are sold. Some open-end funds also have a 12b-1 charge, which is basically an advertising expense. A “pure” no-load fund has no sales, redemption, or 12b-1 charges.

Closed-end funds have no special purchase or redemption costs. The transaction costs (commissions, markups, markdowns) the investor pays are the same as when buying any other stock on listed exchanges or over-the-counter.

Many studies involving large sample sizes have shown that (by group) there is no significant difference in NAV performance between closed- end, load open-end, or no-load open-end funds over long periods, although closed-end funds have an edge. From this, it can appear reasonable that the fund investor should confine interest to pure no-load open-end funds, thereby eliminating sales charges, redemption fees, 12b-1 costs, and commissions, or markups/downs involved in CEIT purchases. The costs reductions add to return by allowing more principal to work.

Everything else being equal, there is no question that pure no-load funds would be preferable. However, all is not equal!

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