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Closed-end Funds or ETFs: Which is Better?

Closed-end Funds or ETFs: Which is Better?

Both closed-end funds and ETFs are investment schemes having almost similar financial objectives, but are structured differently. The difference between closed-end funds (CEFs) and exchange-traded funds (ETFs) is outlined in the WealthHow article below, based on which you can decide which is better among the two and why.
Buzzle Staff
"YieldShares seeks to develop and make available investment vehicles that produce attractive monthly income for shareholders. We expect the YieldShares High Income ETF will set itself apart within the current income ETF space by targeting closed-end funds."
Christian Magoon, Founder of Yieldshares (May 2013)

Closed-end funds (CEFs) and exchange-traded funds (ETFs) are two different investment schemes that have investors confused most of the time. The former has a pre-fixed number of shares. These shares cannot be regained from the fund. The latter is traded on stock exchanges, and is more like an index fund due to its index tracking method. Both have their own pros and cons, and investing in either of them depends heavily on the situation in hand. Go through this Buzzle article and decide for yourself how to choose between the two.
Closed-end funds
  • It is an investment strategy containing a fixed amount of shares.
  • These shares are then bought by investors and listed and traded on a stock exchange.
  • The stock prices change according to the demand and supply of the market and the varying security values of the fund.
  • This stock also targets a specific sector or industry area, and depicts a collection of securities.

Exchange-traded funds
  • It is an investment strategy that owns assets, like stocks and bonds, which are sold as shares.
  • It works on the concept of index tracking.
  • It is also heavily traded on stock exchanges, and its prices fluctuate throughout the day.
  • An important thing to remember is that an ETF does not have its net asset value (NAV) changed on an everyday basis.

Factors of Differentiation

Closed-end funds ETFs
Though they are well-managed, their holdings can be easily viewed on a six-monthly or quarterly basis. Thus, they have less fund transparency. The index functioning allows one to identify the existing stocks and bonds by merely checking the index. Thus, these holdings have a very high transparency.
They are closed funds, i.e., closed once created. Therefore, there are no buying or selling options. Options can be bought and sold here whenever needed.
Management Type
They have an active management type. They belong to the passive management type.
Style Drift
Style drift is the 'drifting' of the fund from one 'style' to another. CEFs are more vulnerable to style drifts. They are generally not susceptible to style drifts, since one cannot select securities outside the index limit.
Incorporating a leverage gives rise to wide variations in the NAV. CEFs are leveraged, and this can benefit the scheme if accurate investment decisions are taken. They do not use a leverage at the moment.
NAV (Net Asset Value)
They do not redeem shares on an everyday basis, and the share price is set by the market, which very rarely gets equal to the net asset value. The share prices are almost always close to the net asset value of the index.
They charge high fees and commissions, since their portfolios are actively managed. Since they are indexed, they have lesser expense ratios.
They are likely to offer a premium or a discount. They generally do not offer a high premium or discount.

Pros and Cons to Discuss
  • CEFs and ETFs share a few similarities, both are traded as a stock, both have expense ratios, and both can be bought on margin, sold by prospectus, etc.
  • It is difficult to decide which among the two is better, for this largely depends on the current financial situation of the market.
  • ETFs have the advantage of an index fund as well as lower fees. They are more efficiently structured to protect the investors.
  • Another important point is their high transparency, which ensures that the investors know what they are buying.
  • CEFs have the leveraging strategy, which may increase the income, but the volatile nature of the NAV also increases.
  • They are actively managed and trade at discounts, which is advantageous.
  • During a financial crisis, however, leveraging may not help, though, during good times, they may provide high yields.
It would be advisable to check and analyze the market situation before investing in either CEFs or ETFs. They both work almost like stock markets; however, they have their own features that tend to vary with demand and supply. Some experts suggest that a mix of both funds may be more beneficial than individual investments. It is however, essential to check the risk and other factors before taking a decision.