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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