Closed end funds
Lets first understand the meaning of Investment Company. An Investment Company is a Company that issues securities and is principally engaged in the business of investing and trading in securities. Thus, the primary object of an investment company closed end funds is to invest in a range of securities.
The investment company pools the funds from individual investors and than, invest these funds in securities of other companies. Thus, by investing through an investment company the closed end funds individual investors have an access to a range of securities, professional expertise of the investment company and also there is reduction in trading cost.
There are three types of investment companies which are recognized by Securities and Exchange Commission (SEC)
-Mutual Funds (known as open-end companies)
-Closed End Funds (known as closed end companies)
-United Investment Trusts (UIT)
Each of the above investment company is explained below-
Mutual Funds-
The Mutual Funds are the companies which collect the funds from the individual investors and than invest these funds in various securities such as shares, bonds, short term money market instruments etc.
The mutual funds or the open-end companies have following characteristics-
-The investors can buy the mutual fund shares from the company directly or through a broker for the fund. Although the investors cannot purchase the shares from any other investor which means there is no secondary market for shares issued by such type of funds. Few characteristics are listed below-
-The investor buys the share from the company or the broker at a price which is equal to Net Asset value (NAV) plus the fees which is to be paid at the purchase of the share (known as Sales Load).
-The shares of the mutual funds are redeemable which means the shares can be redeemed to the closed end funds mutual fund company or the broker for the fund. This sale is at the NAV prevailing in the market at the time of sale plus the fees (known as the deferred sales load).
-The selling of the shares by the mutual fund company is generally not for a limited period of time.
There are different types of mutual funds as index funds, stock funds, bond fund etc based on the type of instruments in which the mutual fund invests.
United Investment Trust-
The United Investment Trusts (UIT) has the following characteristics-
-The UIT dissolve after a fixed period of time which means they have a termination date which is decided when they are created. Some times the termination date is determined by the maturity date of the bonds in which UIT has invested.
-The units of UIT are redeemable which means that the investor can sell the units back to the UIT at the net asset value.
-UIT offers a fixed number of units and only a one time public offering is made, though the UIT sponsors can maintain a secondary market for the UIT units in which the unit holders can sell the units to the sponsors and other investors can buy the units from the sponsors.
Closed End Companies or Closed End Funds-
Closed end companies are the investment companies which issues a fixed number of shares to the public during initial public offer and after this, the shares are traded (bought and sold) in the secondary market. These funds have a fixed number of outstanding shares.
As the shares of a closed end funds are traded in the secondary market the price of the share is determined by the market demand. Unlike, the open end funds (mutual funds) the closed end funds does not redeem the shares rather the shares issued by the closed end funds have a secondary market.
Thus, the closed end funds are the investment company which
pool the funds from the various investors by issuing the shares to the public and invest these funds to buy the securities of other companies. The closed end funds uses there professional expertise to invest the funds collected from the public in various securities.
So, the primary object of a closed end fund is to invest in a range of securities and for investing in the securities it collects funds from the public by issuing a fixed number of shares to them in an initial public offer. An initial public offer means the offer in which the shares are first sold to the public. After the initial public offer the shares issued by the fund are traded in the secondary market which means, the shares are bought and sold in the stock market. Thus, the current market price of the shares issued by the fund is impacted by the demand and supply in the market.
Some of the features of a closed end funds which also identify its disparity from the open end funds are-
-The closed end funds issues a fixed number of shares to the public during an initial public offer.
-After the initial public offer the shares are traded in stock market unlike the shares of open end funds which are not traded in a secondary market. The price of the share is impacted by the demand and supply of the shares in the market and depending upon which the price can be more or less than the shares NAV.
-The closed end funds are professionally managed by investment managers.
-The shares issued by the fund (except a type of closed end fund known as the interval fund) are usually not redeemable distinguishing them from the open end funds.
Types of Closed End Funds-
There are two types of closed end funds-
Closed end stock funds and the Closed end bond funds. These funds can further be classified depending on whether they are holding foreign or domestic securities in there portfolio.
Closed end stock funds-
The closed end stock funds are the funds in which the securities held by the fund in the portfolio are stocks and so, the price of shares issued by the funds that is the funds NAV and the market price depend on the value of the individual stock in the funds portfolio which in turn depends on the market, economic conditions in general and the business activities and financial condition of the issuer company of the individual stock in the portfolio.
Further classifying there may be a domestic closed end funds or an international closed end stock fund depending on whether the stocks held by the fund in its portfolio are of a domestic or a foreign company.
Closed end bond funds-
These are the funds in which the securities held by the fund are bonds. These types of funds are subject to market risk and credit risk.
The credit risk is risk that the issuer of the bonds which are held by the fund in its portfolio may default in the payment of principal and interest.
The market risk is the risk that the interest rate may increase in the market and due to this the value of the bonds held by the fund in its portfolio decreases.
There may be different types of closed end bond funds as taxable closed end bond funds, municipal closed end bond funds and international closed end bond funds.
All the closed end funds are required to be registered with the Securities and Exchange Commission and they are regulated by the Investment Company Act of 1940.
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