Closed-end funds (CEFs) are among the oldest types of investment funds around, having first appeared in 1893. Exchange traded funds (ETFs) came along about 100 years later, facing investors with a choice between two similar-sounding products. Knowing which to choose is a matter of understanding the differences.
Over the past 17 years, ETFs have gathered about $1 trillion in assets under management globally. This is no small feat. CEFs, after all, have attracted about $200 billion in more than 100 years of existence. Although it’s a smaller industry, CEFs do have applications for some investors.
But first, let’s look at the differences.
- Sheryl Nance-Nash for Daily Finance reports that shares of CEFs are created through initial public offerings, after which they trade on major stock exchanges, similar to stocks. ETFs are baskets of shares that track an index.
- CEFs do have expense ratios that are two or three times higher than ETFs. They can be expensive if their assets under management are not substantial because operating costs are divided among the shareholders.
- Although some CEFs have high yields, this is deceiving. These attractive yields are achieved because of a fund’s ability to stay fully invested, their utilization of leverage, and in some instances a return of capital.
- Because CEFs have a fixed number of shares, the market price deviates from the NAV, often by double digits. This inefficiency offers investors the ability to purchase CEFs at a discount to their NAV.
- Most ETFs track an index, while CEFs are nearly always actively managed.
- In most cases, most ETFs have an unlimited number of shares available and new ones can be created easily. CEFs are called “closed-end funds” because once the capital for the fund is raised, no new shares are available.
If you’re seeking high levels of current income, active management and you’re unconcerned with premiums and discounts to NAV, a CEF may be a good choice for you. Otherwise, stick with ETFs. If you want both, the PowerShares CEF Income Composite Portfolio (NYSEARCA:PCEF) is an ETF that holds CEFs. The fund launched on Feb. 19.
Tisha Guerrero contributed to this article.