FAQS

You can think of a mutual fund as “open‐ended” because the cash flow door ‐‐ both into and out of the fund ‐‐ is always open. In other words, the portfolio manager continues to invest new cash from investors, and the fund company continues to offer new shares of the fund to new investors. You can think of a closed‐end fund, then, as “closed‐ended” because the cash flow door ‐‐ into and out of the fund ‐‐ is always (with a few exceptions) closed. The manager only invests a fixed amount of cash that was raised in an initial public offering of the fund’s shares. If you want to buy shares of the fund, you buy the shares from another investor via a stock exchange. The number of fund shares do not fluctuate based on investor demand.

Like mutual funds, closed-end funds are:

• A diversified portfolio of stocks, bonds, or a combination of the two
• Professionally managed by an investment advisor
• Either actively or passively managed
• Required to distribute capital gains and dividends to shareholders
• Regulated by the U.S. Securities and Exchange Commission

A CEF trades like a stock — on a stock exchange or over-the-counter — while an open-end mutual fund is bought and sold directly with the fund company. The cost of the transaction for a CEF is similar to the cost of a stock trade. There are also internal management fees paid to the fund company to manage the fund.

Another cost to be aware of for a CEF is the bid-ask spread. If you place an order to buy a CEF and, at the same time, place an order to sell the fund, the prices for both would be different. In other words, your cost to buy the CEF and the price you would get for selling the CEF would be different. For instance, you might sell at the bid price of $9.90, while you would buy at the ask price of $10. This $.10 difference is known as the bid-ask spread and is considered the cost of doing business on the exchange or over the counter.

You can buy both CEFs and mutual funds through a broker. The broker processes the transaction on the stock exchange in the case of CEF, or with the fund company in the case of mutual funds.

Unlike mutual funds, closed-end funds are:

• Are traded on a stock exchange (NSYE) or over-the-counter (NASDAQ)
• Are bought and sold at market price versus the underlying securities’ value
• Are valued based on supply and demand for the fund
• Can be purchased and sold throughout the trading day
• Use leverage (borrow cash to invest in more assets) to enhance their returns

It is easy to confuse the net asset value (NAV) of the CEF with the fund’s price. To avoid confusion, you can simply think of the NAV as the value of the CEF’s holdings (stocks, bonds, cash, etc.) minus any liabilities, divided by the total number of fund shares that are held by investors. Therefore, unlike a mutual fund, the NAV of a CEF is not the price you pay for a share of the fund.

CEF s are often bought or sold at a discount to their NAV. In other words, if a CEF owns 100 stocks that have a combined value of $1,000,000 with $0 liabilities and 100,000 shares outstanding, the fund has an NAV of $10. Investors might not value the portfolio manager’s ability to pick stocks, however, so they might only be willing to pay $9 per share of the fund. So, this fund would be trading at a discount of 10% to its NAV.

There are many reasons a fund company might decide to structure their fund as a CEF rather than an open-end mutual fund (and vice-versa). It could be that the fund company has a particular niche that is better served through CEFs. For example, if a fund company wants to manage a fund that holds securities that are not easy to trade (illiquid, such as stock of a very small company that is rarely traded on the stock exchange), then they might form a CEF. Another reason to form a CEF, which will also help clarify the previous reason, is because the fund managers of CEF s are not forced to sell a particular security when an investor wants to sell his/her shares of the fund. For example, let’s say we have a manager who is running two funds that differ only in structure — one is a CEF, while the other is an open-end mutual fund. The funds both hold Wal-Mart and Target shares. The fund manager loves both stocks. If an investor wants to sell his/her shares of the CEF, then there is no problem; the fund manager is able to continue to hold both stocks because the investor goes to an exchange to sell his/her shares to another investor. On the other hand, because investors in a mutual fund go to the fund company to redeem his/her shares, the fund manager must sell either Wal-Mart or Target shares in order to meet redemption needs and raise cash for the investor.

Closed-end funds offer regular distributions based on a wide variety of asset strategies. Because of their unique structure featuring minimal cash in or out of the fund, closed-end funds may allow retail investors access to assets and strategies that might not typically be available via other retail investment products.

Because of the many strategies available, income-oriented investors have the opportunity to diversify the sources driving cash flow potential in their portfolios.

This site groups closed-end fund strategies into four main categories:

• Tax-free income funds, also known as municipal bond strategies
• Taxable income funds
• US equity funds
• Non-US equity and income funds

Tax-free* income strategies invest mainly in municipal bonds. Municipal bonds are debt issued by a state, city, or other municipality for general governmental needs or to finance special public projects. Municipal bonds pay interest that is free from regular federal income tax, and statespecific bonds can provide residents of those states with income free from state and, in some cases, local income taxes as well.* Municipal bonds can be an advantageous alternative to taxable investments, particularly for investors in higher tax brackets. To make a fair comparison between a tax-free investment like a municipal bond and a taxable investment, one should adjust the tax-free investment’s yield to account for money saved in regular federal, and sometimes state, income tax.

Municipal bond funds represent the largest single category in the closed-end fund market, offering many national municipal bond funds and several state-specific funds representing 18 different states.

* Interest on out-of-state bonds and dividends paid by national funds may be subject to state and local taxes. Income may also be subject to the Alternative Minimum Tax.

Taxable income strategies include taxable corporate and government bond funds, convertible bond funds, preferred securities funds, and senior loan funds. These strategies invest in incomegenerating securities that may offer high potential income levels, diversification potential, or both for income-oriented investors. These funds offer credit profiles ranging from US government guaranteed to investment grade to high yield or unrated debt, as well as various maturity ranges. They also offer exposure to various portions of the issuer’s capital structure, ranging from senior secured loans down to unsecured junior debt to preferred securities and preferred stock.

Government bonds, bills, and notes are backed by the full faith and credit of the U.S. government, and feature maturities ranging from 90 days to 30 years.

Agency bonds, while not backed by the US Government, are issued by US government agencies rather than the Treasury and also have varying maturities.

Corporate bonds are issued by corporations to finance ongoing business activities, and typically carry ratings from one or more nationally recognized ratings agency. High yield bonds have lower credit ratings or are unrated. This means they are subject to a greater risk of default than investment-grade securities.

Convertible bonds offer the opportunity to convert a bond into the issuer’s stock, giving the investor higher appreciation potential if that stock value increases, but with potentially lower coupon payments when compared to non-convertible bonds with similar credit and maturity features. In some market environments, convertible bonds carry potential risks and advantages similar to bonds, and in others their risks and benefits are more similar to equities.

Preferred securities are usually junior liabilities of an issuer, pay fixed or adjustable rate dividends, have a “preference” over common stock in the payment of dividends and the liquidation of a company’s assets, and often are issued for a finite term. They are not bonds but often have bond-like characteristics like credit ratings and call features. Because they are below bonds in the issuer’s capital structure, they have historically paid higher yields than bonds from the same issuer, while carrying higher risk in the event of that issuer’s default.

Senior loans are commercial loans senior to other loans and debt in a company’s capital structure. Floating rate senior loans have an interest rate that resets periodically, are usually secured by specific collateral, and are often rated below investment grade. Like high yield bonds, this means they are subject to a greater risk of default than investment-grade securities. However, in the event of liquidation, investors in these types of loans are given the highest priority for repayment – before holders of preferred and common stock and subordinated bondholders.

All fixed income bonds carry interest rate risk and credit risk.

Within the larger group of US equity funds are categories investing in general equities, dividendoriented stocks, tax-advantaged stock investments, specific sectors of the stock market, covered call strategies, and REITs, (Real Estate Investment Trusts).

Equities, or stocks, basically represent a share of ownership in a company. The value of that share can rise and fall based a whole host of factors – the company’s performance, market conditions and more.

There are different types of stocks. Growth stocks are from companies that have exhibited faster than average growth or gains. A value stock is one that investors believe may be trading at prices below its perceived market value. Large-capitalization stocks represent the biggest companies. Small-cap stocks are from companies with smaller market capitalization. Many established stocks pay dividends, which are earnings returned to the owners (the shareholders). Stocks that pay dividends on a regular basis are called income stocks. Domestic stocks represent U.S. companies, while international or global stocks represent companies from other countries.

Many investors buy stocks because, historically, as a group they have shown the highest returns. However, the equity markets can also experience periods of extreme volatility.

Covered call strategy funds invest in portfolios of stocks and also sell call options on either individual stocks or stock indices. Some funds may also purchase put options to try to protect the portfolio from extreme drops in the stock market. Potential return from these funds comes from stock dividends, premiums received from selling call options, and stock appreciation (or depreciation).

A Real Estate Investment Trust (REIT) is a publicly-traded company that owns, and usually operates, income-producing commercial real estate, such as apartments, shopping centers, offices, hotels and warehouses. REITs and funds that invest in them typically are designed to provide attractive, growing dividends based on rents or income received from the underlying commercial real estate investments. REIT performance is linked to the performance of the commercial real estate market. Property values and rents may fall due to economic, legal, or cultural developments

Global and international funds invest in equities and debt securities issued by a broad range of companies and governments, and can be diversified across countries, regions, economic conditions and credit ratings.

Global equity funds invest in specific countries or regions, or may invest in certain types of stocks, such as dividend-oriented stocks, from across the world. Global debt funds can give income-oriented investors exposure to debt issued by other countries (this is known as “sovereign debt”) or by global corporations. Some funds also offer income or total return based on actively investing in securities linked to the currencies of various countries, seeking to benefit from the relative strength or weakness of one currency vs. another.

Some fixed-income securities are rated for credit worthiness and payment default risk by independent ratings services such as Standard & Poors and Moody’s Investors Service. Sometimes a fund can gain exposure to the returns of global debt investments more efficiently by investing in derivative securities instead of directly buying non-U.S. bonds.

In addition to the risks linked to stocks or bonds in general, non-US funds also carry additional risks based on their exposure to corporations or countries that may have different accounting, legal, and communications environments, less liquid markets, as well as unanticipated economic, political, or social developments in those countries. However, this exposure to non-US investments often offers additional diversification and/or return potential for shareholders of the funds that invest in them.

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