Closed-End vs. Open-End Investments: What’s the Difference?

Closed-End vs. Open-End Investments: An Overview

Closed-end funds have a fixed number of shares issued by the fund. Open-ended funds don’t have a limit on the number of issued shares. The primary differences between the two lie in how they’re organized and how investors buy and sell them.

Both are professionally managed funds that achieve diversification by investing in a collection of equities or other financial assets rather than in a single stock. They also both pool the resources of many investors to invest on a larger and wider scale.

Key Takeaways

• A closed-end fund has a fixed number of shares offered by an investment company through an initial public offering.
• Open-end funds don’t have a fixed number of shares.
• Open-end funds are offered through fund companies that sell shares directly to investors.
• There are significant differences in the structure, pricing, and sales of closed-end funds and open-end funds.

Closed-End Investments

A closed-end investment is overseen by an investment or fund manager and is organized in the same way as a publicly traded company. This type of fund offers a fixed number of shares through an investment company, raising capital through an initial public offering (IPO). Shares are listed on an exchange after the IPO. Investors can purchase them through a brokerage firm on the secondary market.

Closed-end funds can be traded at any time of the day when the market is open. They can’t take on new capital after they’ve begun operating but they may own unlisted securities in the U.S. There are also interval funds, a type of closed-end fund that doesn’t trade in the secondary marketplace.

The nature of each type of fund affects how it’s priced. Closed-end investment shares reflect market values rather than the net asset value (NAV) of the fund itself. They can be purchased or sold at whatever price the fund is trading at during the day. Demand drives share prices. Market demand determines the price level for closed-end funds so shares typically sell either at a premium or a discount to NAV.

Closed-end funds are more likely than open-end funds to include alternative investments in their portfolios. These can include futures, derivatives, or foreign currency. Examples of closed-end funds include municipal bond funds that try to minimize risk by investing in local and state government debt.

Distributions from closed-end funds come from several possible areas. They can come from dividends, realized capital gains, or interest from fixed-income assets held in the funds. The fund company passes the tax burden on to shareholders, issuing them an IRS form 1099-DIV with the breakdown of distributions every year.

Open-End Investments

You wouldn’t be entirely wrong if you heard the term open-end fund and immediately thought of a mutual fund. A mutual fund is one type of open-end fund. Other types include hedge funds and ETFs. They’re offered through fund companies which sell shares in each directly to investors. Open-end funds can take the form of SICAVs in Europe and OEICs or unit funds in the U.K. outside the United States.

Open-end funds are traded at times during the day that are dictated by fund managers. There’s no limit to how many shares an open-end fund can offer. They’re unlimited. Shares will be issued as long as there’s an appetite for the fund. The fund company creates new replacement shares when investors buy new shares.

Prices for open-end funds are fixed once a day at their NAV and they reflect the fund’s performance. This value is the fund’s assets minus its liabilities. This is the only price at which fund shares can be purchased that day.

Some open-end funds charge investors a fee that occurs when shares are purchased or when they’re sold. A front-end load is a fee or commission that’s charged when an investor initially purchases shares in the fund. This is a one-time charge and isn’t incurred as an operating expense.

The back-end load is a fee charged to investors when they sell shares in mutual funds. The fee amount depends on the value of the shares being sold and is usually charged as a percentage. Other open-end funds won’t charge investors a fee at all. These are known as no-load funds.

Important

Open-end investments such as mutual funds don’t pay taxes themselves but pass on the taxes to their investors who pay on any capital gains or income derived from these funds.

Use This in Real Life

Let’s say a closed-end fund’s shares are being traded on the New York Stock Exchange. It has more than $335 million in assets under management and 21.3 million shares outstanding. It’s trading at a discount of -2.96% and it has a current monthly distribution per share of $0.0882. The fund has 161 holdings and a market price of $11.82. You’d have to buy 10,000 shares for $118,200 to achieve a monthly income of $882.

Now consider an open-ended fund with just under $42 billion in assets under management. This fund tracks the S&P 500 Index and has a net expense ratio of 0.01%. It holds the stocks of 504 companies and is open to new investors who can purchase shares through a broker. Gains are made by increases in a share’s market price. The fund is coming off a one-year return of 29.85%, a five-year return of 15.04%, and a 10-year return of 12.94%.

Which option is right for you? It depends on how much of a return you’re looking for and when you want to achieve it.

Is an ETF Open- or Closed-End?

Exchange-traded funds are open-ended because they’re offered to new investors and can grow in share numbers. Closed-end funds don’t grow their shares and are offered through an IPO.

What’s the Difference Between Open-End and Closed-End REITs?

Closed-end REITs have a predetermined life span or a target date set by the fund management to take advantage of capital gains. Open-ended REITs have no termination date. Investors expect an income stream rather than capital gains from sales.

What’s the Difference Between Open-End and Closed-End Management Companies?

Open and closed-end funds are legal companies that are registered to offer shares. These companies can offer shares as part of an IPO (closed-end) or continuously offer shares on the market (open-end).

The Bottom Line

An open-end fund doesn’t have a fixed number of shares but allows investors to purchase shares continuously at market value. A closed-end fund is generally a one-time offering to investors. These shares can be traded on the market and are often traded at either a premium or discount to the shares’ market value.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.