Closed-end Funds Offer Risk and Reward

Physician's Money Digest, September 2007, Volume 14, Issue 9

Exchange-traded funds (ETFs) may be all the rage, but savvy investors might find some hidden treasure in closed-end funds. Closed-end funds have a fixed number of shares with specialized portfolios and are traded on a stock exchange at a price determined by the number of buyers and sellers. Plagued by limitations such as a lack of interest by research firms, a history of mediocre performance, trade discounts off net asset values, high fees, and a lack of high return, closed-end funds lack the popularity of ETFs. However, closed-end funds may offer investment opportunities for those that take a patient, yet aggressive, approach.

By anticipating shareholders' losses, investors can take advantage and gain a profit. AAII Journal suggests that investors jump on closed-end funds when they are most vulnerable: when discounts widen due to market downturns, tax-loss selling, or rising interest rates; and, when dissident shareholders try to convert or liquidate the fund. Basically, by buying shares when the fund is vulnerable and waiting for the possible rise, investors can steal a deal. For those willing to research and stay aware, closedend funds may be hidden gems. It’s important, however, to keep an overall diversified portfolio to limit the risk associated with closed-end funds.