While exchange-traded funds and mutual funds generally claim the spotlight, closed-end funds (CEFs) offer unique attributes for discerning investors.

We explore five – trading agility, undervalued gems, potential income generator, leverage, and strategic access – and why they present a compelling case for investors.

1. Trading agility

Unlike mutual funds, CEFs operate with a fixed number of shares issued during their initial public offering. Shares of CEFs trade on a stock exchange, like other stocks and ETFs, allowing investors to buy or sell at market prices throughout the day. This intra-day liquidity transcends the limitations of mutual funds, which restrict investors from transacting directly with the fund itself at its net asset value (NAV) once a day after the market closes. CEFs' trading flexibility empowers investors to react to market shifts and to capitalize on opportunities in real-time, treating CEF shares the same as any other exchange-traded security.

2. Undervalued gems

Because CEFs have a portfolio of securities, like mutual funds, they have a net asset value (NAV). Yet, because their shares trade on an exchange, they also have a share price. Unlike ETFs, there is no internal mechanism to keep the NAV and share price near equilibrium.

Therefore, CEF share prices typically trade below their NAV, or “at a discount”. Such price discrepancies may create potential opportunities for astute investors, because identifying CEFs trading at a discount to NAV may mean potentially acquiring assets at a bargain – if the price narrows the distance to a steady or rising NAV over time.

However, it wouldn’t be prudent to buy a fund simply because it is trading at a discount. It’s important to first understand why a fund may be trading at its current discount and what the fund’s historical discount range has been. Also, bear in mind that it is a feature of closed-end funds that they trade at discounts. There is little aside from market sentiment to make their share prices converge with their NAVs. Finally, over the long term, the distribution rate will likely have a larger effect on total return than will the fund’s discount at the time of purchase.

3. Potential income generator

Unlike mutual funds and ETFs, most CEFs’ top investment objective is consistent income generation, distributing a portion of their realized gains and income to shareholders. Most CEFs were designed – before their IPO – to make such distributions.

Managed distribution policies, whereby CEFs pay out a certain percentage of their NAV every month or quarter, are common. Many CEFs have regulatory approval to distribute capital gains more than once a year, thereby largely avoiding the year-end tax surprise so common to many mutual fund and ETF investors.

Consistent, regular distributions are a compelling attraction for income-seeking investors, particularly retirees. Furthermore, many CEFs offer the option to reinvest distributions automatically, compounding returns for younger investors in the wealth accumulation stage.

4. Leverage

Another potent weapon in a CEF's ability to generate distributions is leverage. While open-end funds are restricted in their borrowing ability, CEFs can strategically employ leverage to potentially amplify earnings, returns, and distributions. Leverage also increases volatility, so investors need to understand their risk tolerance before investing in leveraged CEFs.

5. Strategic access

Closed-end funds are so-named because, after their initial public offering, their capital is closed – they don’t have to hold readily liquid securities to sell at a moment’s notice should investors decide to sell their shares. Shares sold are sold on an exchange to other investors who are buying, not to the fund itself. This differs markedly from a mutual fund.

Therefore, CEFs have greater freedom to invest in unique investment opportunities. They can venture into niche asset classes and employ specialized strategies that are generally inaccessible in mutual funds or ETFs.

For instance, a CEF might invest heavily in private infrastructure, offering individual investors exposure to a part of the market that they otherwise would not have access to via a security – the CEF – that they can sell intraday on a stock exchange. This ability to access differentiated segments of the market expands the investment universe, enhancing portfolio diversification.

Final thoughts

For investors seeking funds with an income objective, access to unique asset classes, and active management, CEFs present a compelling case. Delving into their unique attributes can broaden the investment universe and help investors navigate the financial landscape with greater confidence.

Important information

Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund's investment return and principal value will fluctuate so that an investor's shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund's portfolio. There is no assurance that the Fund will achieve its investment objective. Past performance does not guarantee future results.

The use of leverage will also increase market exposure and magnify risk.

Closed-end funds are similar to mutual funds in that they professionally manage portfolios of stocks, bonds or other investments. Unlike mutual funds, which continuously sell newly issued shares and redeem outstanding shares, most closed-end funds offer a fixed number of shares in an initial public offering (IPO) that are then traded on an exchange. Open-end funds can be bought or sold at the end of each trading day at their net asset values (NAVs). Because closed-end funds trade throughout the day on an exchange, the supply and demand for the shares determine their market price; closed-end funds'; market prices may fluctuate through the trading day and those prices may be higher or lower than their NAVs. Closed-end funds and mutual funds charge investors annual fees and expenses. All of these products may use leverage to enhance their returns, which can magnify a fund's gains as well as its losses. Closed-end funds typically do not have sales-based share classes with different commission rates and annual fees. Both vehicles seek to deliver returns based on their investment objectives, but neither is FDIC-insured. The Revenue Act of 1936 established guidelines for the taxation of funds, while the Investment Company Act of 1940 governs their structure. Aberdeen Standard Investments does not provide tax or legal advice; please consult your tax and/or legal advisor.