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Closed-end mutual funds

Comparing closed-end and open-ended mutual funds. Created by Sal Khan.

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  • male robot donald style avatar for user Bryan K.
    I have a question (or maybe a few), why would investors buy into a close-ended mutual fund in the first place? Does a close-ended mutual fund pay dividend? What is the incentive for investors to buy into a close-ended mutual fund if they are liable to sell their own shares to the public? It doesn't really make sense to buy into a close-ended mutual fund over an open ended mutual fund.
    (7 votes)
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    • leaf blue style avatar for user Pi is the best
      A big advantage to a closed-end fund is they don't have the tax consequences of a open-ended fund. Lets say there are a lot more people selling shares than buying shares in an open-ended fund. Now the fund has to start selling its assets to meet redemption requirements. This can force the fund to take a capital gain or loss depending on the value of the assets at time of sale. The capital gains is usually returned to the investor as a "dividend payment", but you are now force to pay tax on that gain even though you never sold your shares in the fund. If this same scenario happen in a closed-ended fund you would not owe any tax until you actually sold your shares. This can allow for more efficient tax planning. I would to stick to exchange traded funds (ETF's) instead of closed-end mutual funds.
      (8 votes)
  • leafers seed style avatar for user Yash Dalmia
    So, what is the difference between closed end mutual fund and stocks of a company ? (except the dividends part and the management fee)
    (3 votes)
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    • male robot hal style avatar for user Andrew M
      There isn't really all that much difference. A closed end fund is basically a company whose only business is holding stocks. Instead of assets like factory equipment, a closed end fund's assets are stocks. Closed end funds may pay a dividend, as can any other company.

      Closed end funds have high management fees and they are basically a way for the manager to gather a permanent pool of assets from which he can keep extracting fees, year after year after year. In general you should stay away from them, except on occasion when they are priced at a significant discount to the value of the stocks they hold. That's a strategy for a relatively sophisticated investor. Most should stick to low-fee, diversified open end funds or ETFs.
      (6 votes)
  • blobby green style avatar for user riddhi119
    If a closed-end fund could raise capital by secondary offering, how is it any different from the open-ended fund? Because both of them are able to raise capital by creating new shares. So, how is a closed-end fund actually "closed"?
    (3 votes)
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    • male robot hal style avatar for user Andrew M
      First, a lesson in terminology. It's not a secondary offering it's a follow-on offering. A secondary offering is not done by the original issuer, it's done by someone else who owns a lot of shares. This is a common mistake but definitely a mistake.

      Now...
      This question is like saying "Oh, Amazon is just like an open end fund because it has follow-on offerings"
      The closed end fund never offers redemptions
      Offerings happen only very rarely, whereas open end fund offer purchases and redemptions daily.
      The open end fund shares always match NAV. Closed does not.
      Closed funds are ripoffs. Forget about them.
      (6 votes)
  • starky ultimate style avatar for user P.Vishesh.22
    If you cant make additional shares and raise money, why would you prefer a closed end fund over an open ended fund?
    (3 votes)
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  • hopper cool style avatar for user Sara
    Can you go around getting investors for a year and then close it?Or does it have that for a day you go around getting investors and then you HAVE to close it.
    (3 votes)
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  • piceratops seedling style avatar for user Eair
    I've been researching mutual funds. How am I supposed to know if a fund is closed or open ended? Also, what does it mean when a mutual fund says it's "closed to new investors"?
    (3 votes)
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  • piceratops tree style avatar for user rheanna diego
    Am I the only one that actually googled "The Galileo Fund"? I found it
    (2 votes)
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  • piceratops ultimate style avatar for user Sean Bartell
    Are closed-end fund shares equivalent to shares of stock in a company that doesn't give dividends?
    (1 vote)
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  • mr pink orange style avatar for user smwalters55
    I'm unsure about why you would choose to invest in one over the other. It seems like it would be riskier to invest in the closed-end mutual funds-- but I'm not sure. Would someone be able to explain the pros/cons of each, or specific reasons why someone would choose to invest in an open-end fund rather than a closed-end fund, and vice versa?
    (1 vote)
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    • male robot hal style avatar for user Andrew M
      Closed end funds generally have high fees and are not worth bothering with. They are sold to suckers by brokers who make money on the sale. They are structured as closed end funds just to ensure the manager a permanent stream of management fees. The only reason you might want to buy a closed end fund is that sometimes they sell for a bit below their net asset value. But there's no guarantee that they will close that gap, and while you are waiting you will be paying high fees.

      Stick with open end funds, preferably low-expense, diversified index funds.
      (3 votes)
  • piceratops seedling style avatar for user Arslan Abdullah
    What's the advantage for Pete to have an open fund? If in a closed fund, Pete doesn't need to keep a small percentage of the assets as cash, and investors can't pull out of a closed fund (unless they trade their share with another investor), then what is the real advantage of an open fund where investors can pull out any time and Pete may have to liquefy his assets as a result to satisfy worried investors?
    (2 votes)
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Video transcript

In the last video we had Pete starting an open-ended mutual fund that was managed by Pete Inc. Mutual Funds normally have nice grand names maybe they called this the Saturn Fund and if there is a Saturn Fund out there, I just picked that name at random I'm not implying that this is you or anything like that I just made up that name on the fly But it's managed by Pete Inc. and we called it an open-ended fund because at any time one of the people who owned a share or unit in the fund can redeem it back from the fund that Pete or the management company would say If you want your $180 back we'll buy that we'll give you $180, you give back the share, and then we cancel the share and if anyone wants to add to the fund if they want to invest the corporation can create new shares and then issue it to people - sell it to people and their money would go into the common pool and the management company would take fees off of it But that probably had you asking If this is an open-ended fund, what is a closed-ended fund or do they even exist? And they do That's what I'm going to talk about here Closed-end funds and closed-end funds on some level are a little bit simpler What happens in a closed-end fund is that all of the investors are essentially Or I guess you can say that the share structure is locked from the beginning So if Pete wanted to start a closed-end mutual fund he would once again register a corporation with the SEC he would market it it he would tell everyone "Hey I'm Pete, I'm an awesome investor" "Here's my track record" and then he would just get a bunch of investors so lets say he's able to find 20 investors and that's all he's able to find so this is 20 right here, and I'm not going to count but, let's say that there's 20 slices right over here He gets 20 people, so let's say they each give $100 so he is able to raise $2000. 20 times $100 So he is able to raise $2000 And once that happens, the fund is closed. Pete's going to do his best to manage this So Pete will manage this and he will still take a management fee Maybe the same 1% But what's fundamentally different here and he can market - well he doesn't have to market the fund anymore because he can no longer get new investors and this is actually the main difference An open-ended mutual fund at any point in time or I should say at the end of trading at the end of a day, they can lose investors, or they can gain investors so it's an incentive for an open-ended fund to constantly market itself because the manager wants to manage more money so that he gets more of a management fee And a closed-end fund They'll market it right when they are creating the fund But once they create it So lets say he just got his 20 investors Then it is closed He can't create any more shares or cancel any more shares But what can happen so you might say well in a closed-end fund How do these people let's say you're holding one of these shares let's say that you're holding one share right over here what happens if you want to If you need to buy a house, or if you owe money to somebody so you want to get the value of your share back and the answer with a closed-end fund is that you would then go sell your share to someone else so this right here you can trade it You can trade it and you would trade it just you would trade the stock of any company And in fact when you go and buy or sell a stock of IBM, most of the time you're just buying or selling it from someone else You're not transacting with IBM the company You're trading in the secondary market you're not dealing with the actual corporation so that's where the investor get's their liquidity and when we say liquidity it allows them to convert it into cash because they can trade it So the big difference open-ended fund: when an investor wants their money back they have to deal with the fund itself the fund will buy back their share If some wants to invest in a fund the fund will sell them the share so they're always dealing with the fund itself in a closed-end fund once the fund is created it's share pool is fixed and if someone wants to buy or sell a share it happens in the secondary market so they're buying and selling from each other they're not dealing with the actual fund manager The disadvantage from the fund manager here is it's much less flexible in terms of growing or shrinking the fund The advantage is this fund manager doesn't have to keep cash around in case the share holders want to redeem In the open-ended fund we saw that the manager has to keep some cash around in case one of these investors wants their money back here - the closed-end fund - he knows that no one can get their money back right here so he or she can invest as they see fit