Content provided by Joshua Jenkins, CLS Associate Portfolio Manager

The ETF industry spends a substantial amount of time educating investors on the relative merits of the Exchange Traded Fund (ETF) structure. In doing so, a comparison is typically made to a close relative, the open-end mutual fund. There is, however, another investment vehicle defined by the Investment Company Act of 1940 that is frequently overlooked – the Closed-End Fund (CEF).

CEFs Defined

A CEF is a publicly traded investment company that offers investors an efficient means of obtaining both active management and broad diversification. CEFs are created through an initial public offering (IPO) and maintain a fixed number of shares. Unlike ETFs or traditional mutual funds (open-end funds), CEFs do not issue or redeem shares as investors buy into or sell out of the fund. Instead, investors buy and sell shares like they would an ETF: intraday on a stock exchange.

Share prices for CEFs can deviate from the fund’s net asset value (NAV). The NAV represents the market value of all securities within the fund plus all other assets, less all liabilities, and divided by the amount of shares outstanding. Over time, supply/demand imbalances for the fund can cause the share prices to trade at a premium (above NAV) or at a discount (below NAV).

Potential Benefits of CEFs

Perhaps the biggest benefit of CEFs comes from the potential ability to buy assets below their intrinsic value. If supply exceeds demand for a CEF to a high enough degree, the discount to NAV can grow to 10 percent or more. This can offer an extremely attractive opportunity for investors to purchase assets for substantially less than they are worth. In addition, certain CEFs utilize leverage that is typically not found in other fund structures. Leverage offers an investor the potential to increase return generated on an asset with the trade-off of increased risk.

The CEF Market

According to the Investment Company Institute (ICI), entering 2015, there were 568 CEFs on the market with approximately $289 billion in assets under management. While assets in the CEF structure have experienced a net increase over the last 10 years, fund liquidations and mergers have outpaced new fund launches, resulting in a decrease in CEFs on the market. Despite this consolidation, CEFs still represent a material slice of the industry and can provide an attractive vehicle for investment.

CLS uses ETFs and CEFs within its newly launched Active Income X Strategy. You can read more about the use of these investment vehicles in our strategy by visiting this webpage.

Source: Investment Company Institute

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1936-CLS-6/30/2015