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Closed-end vs Open-End Mutual Funds

The general term “mutual funds” usually refers to investment vehicles more specifically known as open-end mutual funds (the “mutual funds” denomination has become so mainstream that the open-end classification is commonly omitted). However, there exists a second mutual fund category identified as closed-end funds. This category is lesser known and much smaller: Closed-end funds total only $216 billion in net assets, compared to $8.4 trillion for open-end funds. Three important differences between these two categories of mutual funds are outlined below.

Share issuance: Open-end funds can issue an unlimited amount of shares and then redeem them on demand. Closed-end funds generally issue a fixed number of shares at inception in a process known as an initial public offering (IPO). These shares are then traded on an exchange, similar to stocks. A closed-end fund can issue new shares after the IPO, but this is rare. A closed-end fund can, if it chooses, convert itself to an open-end mutual fund and issue an unlimited number of shares.

Share transactions: Shares of an open-end mutual fund can be purchased directly from the fund at any given time. An investor can go directly to the fund company and buy shares, or sell shares back to the fund if he or she already owns them. In contrast, closed-end fund shares trade on an exchange, like stocks, and are normally purchased through a broker, who charges a commission. Closed-end shares can be bought and sold during normal market hours and, as a consequence, their market prices also fluctuate throughout the day. Open-end shares are only priced once a day at market close.

Share price: The price of open-end fund shares is equal to the net asset value, NAV (the value of all the fund’s assets divided by the total number of shares). For closed-end funds, it’s not that simple. Since closed-end funds are traded on an exchange, prices are established by the market, and shares can trade at prices different than the fund’s net asset value. If the price is higher than the NAV, shares are said to be trading at a premium—investors are willing to pay more than the fund is really worth. Conversely, if the market price is lower than the NAV, the fund is trading at a discount. This can be considered an advantage of closed-end funds over open-end ones: who wouldn’t want to buy something at a price lower than its true value?

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