Hi I'm Jimmy in this video we're
gonna look at. Closed end funds.
We're gonna look at the basics of
what a closed end fund is how
they compare to things like mutual
funds or ETF.
And then we're gonna look very
quickly at a couple examples to
illustrate what types of funds are
out there. OK so a closed end fund
is actually a type of mutual fund.
And I think it's easier for us to
understand what a closed end fund is
when we compare it to traditional
mutual fund into exchange
traded funds.
So we have closed end funds
traditional mutual funds which they
actually call open ended funds
and then exchange traded funds.
Many of those called ETF for short.
So the first thing is that each of
these funds are publicly traded
funds but how they are traded
is one of the key things that
separate how each of them operate.
So let's start with traditional
mutual funds.
Now many people have this type
of fund in there 401K
plan or a retirement account.
It's the classic fund
and it is one of the most popular
funds out there.
Even though ETF saw rising
as of right now mutual funds
still have a lot more assets in
them. So if we want to invest in a
mutual fund well mutual funds
only actually trade one time
per day only once per day after
the market closes.
Do they take in new money and get
rid of the money that people are
trying to withdraw.
So after the market closes
the price of that mutual fund is set
based on the underlying holdings
prices and all the money that
all the new money that got
investigates added to the portfolio
all the money that people sold their
shares. That gets taken out of the
portfolio and then it begins
for the next day.
So this is actually one of the main
reasons that mutual funds tend
to keep a decent amount of cash on
hand. That way they can handle any
redemptions and they don't to sell
shares of underlying holdings.
So that's one of the main ways that
mutual funds work but you can only
do it once per day.
Now we switch over to the rapidly
growing ETF space now
ETF so unique because their prices
are constantly being reset
to represent the fair price
of the holdings that are in the ETF
except for mutual funds do it once a
day ETF do it constantly
and therefore they can be traded
anytime that the stock market is
open. This is one of the things that
makes ETF so appealing
now is all too also interesting
because where the quoted price
of mutual fund may differ slightly
during the day well
ETF is don't have that issue because
once again they're constantly being
reset. So as an example
if we were going to invest in an ETF
and nobody else anywhere wanted to
buy that ETF and we decided we're
going to buy 100 thousand shares
of that ETF.
So one hundred thousand shares was
all the volume for the entire day.
Nobody else bought or sold anything.
Now let's pretend that the ETF
creators had to sell us
new shares since nobody
else is willing to sell their
shares.
Well it's possible that the
ETF would still be down
for the day if the stocks
in that ETF were
down.
Even if we all of the
orders placed for that ETF were buys
in theory the demand was greater
than the supply.
Well the stock the ETF could still
be down because it is the underlying
shares that ultimately drive the
price of the ETF instead
of the price of the ETF
running up. Well the ETF provider
would simply create more shares and
create another basket of Call of
shares. When people buy or
they redeem a basket of shares if
people want to sell.
Now I bring this out in a closed end
fund primer video because this
is key to understanding closed end
funds so closed end funds
trade just like an ETF does.
So you can buy them anytime during
the day that the market is open.
They trade just like stocks just
like you. Yes except
when we buy a closed end fund.
The money that we invest in that
fund never actually goes into
the fund.
It never goes near the companies
that that fund holds.
Instead when we buy or sell
a closed end fund we are always
either buying from other investors
or selling to other investors.
So here's how it works.
Let's imagine that a new closed end
fund is being set up and
it's getting ready to launch.
So before it does there is initial
public offering or an IPO for
short. And usually it's an
investment bank that sets that up
and they put the initial money in
either for themselves or maybe for
their clients.
So they do an IPO they put it into
the fund.
In this example let's pretend that
they're going to add five hundred
million dollars to the fund.
Now before the fund starts trading
to the public they close the fund
and that fund will no longer
take any additional money
hence the term closed end fund.
Well then that fund starts to trade
to the public.
So when an investor goes ahead and
they jump on their computer and they
start to sell or buy shares
of that particular closed end fund
well they are buying or selling
they're exchanging money directly
with other investors not
from the fund itself.
So where shares outstanding
in a mutual fund or an ETF
change based on the buys
and sell orders that come in.
Closed end funds don't change.
They fixed the number of shares
outstanding and then they let the
shares free.
They let the shares trade rather
freely. So this is where things
actually get really interesting with
closed end funds.
Let's think about this for a second
so let's stick with our example
of the new closed end fund that's
launching with five hundred million
dollars.
And we know that we'll have a fixed
number of shares outstanding.
So let's imagine that those that
they have 10 million shares
outstanding which means that
going public their shares
outstanding coming public at about
fifty dollars per share.
But there's a lot of excitement
about this particular fund and
investors come rushing in
and because they are trading with
each other.
Supply and demand the supply
is limited demand drives the price
higher the share price climbs
all the way to fifty five dollars
per share. So let's say that that
level right there that's the fifty
five dollar level.
This particular closed end fund is
trading.
But the stocks
at that are in the closed end fund.
Not too much has happened.
In fact let's imagine that
the fair value of all the stocks
and bonds or preferred
shares or whatever happened to be in
this particular closed end fund.
Well they're
because nothing has happened the
fair value of all of the underlying
holdings is still just 50 dollars
per share.
They call this the net asset value
or NAV for short.
Well clearly we can see right now
that the fund is trading at a higher
level than the underlying net
asset value.
They call this trading at a premium.
Personally I think we're probably
less interested in owning a fund
when these shares are
trading more it's more expensive to
buy the fund than it is to just buy
the underlying holdings.
Well we're not the only ones to
think this so other investors
start to sell and we also sell our
shares and as we
do that the price of this fund
begins to fall.
Well a few weeks later the price of
this particular closed end funds
that share the share price has
fallen all the way down to forty
five dollars.
But in our end our very questionable
scenario here the net asset value
of all of the particular holdings in
this fund have remained right
at about fifty dollars per share.
So the NAV is still at fifty
dollars per share but as we could
see we can buy the fund for just
forty five dollars per share and
they call this trading at a
discount.
So this is one of the real
advantages of closed end funds
we can buy them for less than
they are truly worth or at
a discount.
Another way to look at it is we
could instill a discipline in our
investment style that we will only
buy funds that are trading at a
discount.
So this is one of the positives
of being able to invest in closed
end funds.
What are the negatives you ask.
Well out of the 500 or so closed end
funds that I could find that were
available in North America.
Well I calculated the average
fee for these funds
and the fee was higher than 1
percent.
And considering that many ETF
s are trading for just a few basis
points. Well it would seem a closed
end funds have high fees.
But let's ask a question.
Would we be willing to buy a closed
end fund like LNP Capital
Income Fund which has a fee of about
one and a half percent but
they pay a dividend of almost
9 percent.
They're trading at a discount of
almost 10 percent and
the average total return on
an annual basis for the past 10
years is about 13 percent.
It's higher than the S&P 500.
That's of course assuming we
reinvested all the dividends back
into this particular closed end
fund. See in my eyes the fact that
closed end funds can trade at the
discount.
And in theory we could limit
our purchases of closed end funds
to only funds that are trading at a
discount.
Well in theory that could offset
some of the pain that we feel with
the higher fees.
Now I'm not saying that all closed
end funds traded higher fees.
Some don't.
Let's take a fund like the Ellsworth
Growth and Income Fund.
Well their fee is only twenty seven
basis points and it trades at an
almost 9 percent discount
to its NAV and
it's got a dividend yield of almost
5 percent plus
its total return its average total
return on an annual basis is about
twelve percent going back the past
10 years.
To me that's not too bad at all.
Now they're all different types of
closed end funds.
There are bond funds or equity
funds there are taxable fund.
There are taxes that exempt
municipal bond funds
and the good news
is that closed end funds are managed
by Professor professional portfolio
managers.
So if that's something that we're
interested in well this could
be a good way to get it.
Assuming we buy them tactically
and we're aware of what they often
what they bring to the table.
So at the end of the day I think
that closed end funds can be a good
investment if we analyze
the funds closely we understand what
they're in and what they're
charging us for.
And also I think it's important
to point out that many core closed
end funds are fairly highly
leveraged.
And that is something
we want to account for every fund
has to report how much they've
leveraged.
And in theory we can use that
information to decide if it's
leverage work.
We're OK with if we're comfortable
with another important consideration
is the tax implications of the
dividends we received from closed
end funds.
So dividends
tend to be an important part of
closed end funds but often
those can be the dividends we
receive can be accounted for as
capital gains.
And that could have an impact on our
taxes.
It all depends on our personal tax
situation. But I think it's an
important thing for each of us to
consider.
So my question to you is
Have you ever invested in the closed
end fund or would you invest in a
closed end fund.
Do you think they're good investments.
Do you think that we should analyze
any of these closed end funds
closer. The two examples that I gave
here I have no particular opinion
on them. I just went through and
looked for some examples to give.
But should we do a deeper dive
in either one of those closed end
funds one of those are perhaps
different one. Please let me know
what you think of the comments
below. And if you haven't done
so yet hit the subscribe button
gets a thumbs up. It really helps
everything we're doing.
I appreciate you sticking with me
all the way to the end of the video
are seeing the next video.
Thanks.