A closed-end fund is a publicly traded investment company that invests in securities according to its investment objective. When a new closed-end fund is established, it begins by raising capital to invest through an initial public offering (IPO) of its shares to the public.
Such funds are referred to as "closed-end" because, once the initial capital is raised, there are typically no more shares available from the fund sponsor. Effectively, the issuance of new shares is closed.
After the IPO, most closed-end funds are listed and traded between investors on a national exchange, such as the Nasdaq or the New York Stock Exchange. The shares are not sold and redeemed by the investment company itself.
The typical closed-end fund utilizes a specific investment strategy and is invested in an actively managed portfolio of holdings. The total price of these securities on the open market collectively constitute a value, known as the Net Asset Value (NAV). However, a closed-end fund’s market price may differ from its NAV. That is because a closed-end fund’s market price is also affected by market factors, including supply and demand. These other factors may result in the fund’s shares selling at either a discount or a premium to the net asset value.
While the outstanding shares of a closed-end fund remain relatively constant, additional shares can be created through secondary offerings, rights offerings or the issuance of shares for dividend reinvestment.
The first closed-end fund was established in the U.S. more than 100 years ago, in 1893. Today, there are more than 600 closed-end funds, some of which have management and performance histories that go back over 50 years. Since investors often buy and hold closed-end fund shares for long periods of time, it is common for shares to be passed down from one generation to the next.
The Investment Company Act of 1940 created the legislative framework that has supported the enormous popularity of closed-end funds and mutual funds today. The 1940 Act laid out clear guidelines for fund companies and gave investors confidence to take advantage of the unique opportunities these investment vehicles offer.