Website Screenshots by PagePeeker Introduction to Investment Funds – Open-Ended VS Closed-Ended Funds – Heres The Answers

Introduction to Investment Funds – Open-Ended VS Closed-Ended Funds

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What are they?

Open and closed-end funds are both collective investment schemes. They pool the money of investors into a professionally managed portfolio in order to maximize diversification within a set strategy and to meet specific investment objectives.

The difference between open-ended and closed-ended funds is in how the fund is structured.

Open and close ended funds can also be tailored for different levels of risk appetite dependent upon individual investment strategies and objectives. This enables flexibility and the opportunity to diversify investments, allowing assets to be allocated among many different types of holdings meaning the fund is not overly affected by the fluctuation in price of only one stock. Also, some funds invest in certain sectors or industries which can cause the value of the portfolio to naturally fluctuate which again has the potential to affect the returns of the fund.

Open-Ended (OE):

An open-ended fund is one which has unlimited availability as it can issue and sell an unlimited number of units to its investors.

An OE fund issues and redeems units on demand. When an investor buys open-ended fund units the fund's assets rise as money is added to the asset pool, even if an investor liquidates their investment the fund's assets decline as money is taken from the pool. The value of open-ended funds is therefore equal to their Net Asset Value (NAV) which can grow and shrink as money flows in and out. This means the more investors buy into a fund the more shares there will be.

By their very nature open funds are more flexible and can provide instant liquidity as funds sell units daily.

This does however mean that open-ended funds can be at risk of sudden inflows or reductions, leading to spikes of growth or a fall in the value of the fund's portfolio which can affect fund returns.

Closed-Ended (CE):

A closed-ended fund is a collective investment fund which has a limited number of shares. Just like any other limited company, it issues a set number of shares in an initial public offering and they trade on an exchange. Its share price is determined not by the total value of the assets it holds, but by investor demand for its shares. Once the fund's capital is fully issued, investors must buy shares in a secondary market from existing shareholders.

A CE fund is different from an open-ended fund in a number of key ways.

Unlike an OE fund, the buying and selling activity of closed-end funds does not directly affect the fund's assets as the number of shares issued is fixed. This means that the value of closed-ended funds can deviate from the Net Asset Value (NAV) dependent upon market share price. Positive deviation is named as premium and negative deviation as discount.

The prospect of buying closed funds at a discount makes them appealing to experienced investors. The discount is the difference between the market price of the CE fund and its total net asset value. As the stocks in the fund increase in value, the discount usually decreases due to the demand for more shares. As the demand increases the share price increases and may move higher than the NAV, at which point the shares will be trading at a premium.

Shares can trade at a hefty discount, under the true value of the shares. Therefore most investors purchasing closed-end funds look for those with solid returns that are trading at large discounts. They bet that the spread between the discount and the underlying asset value will close. However the mechanisms of evaluating this discount spread can be complicated for inexperienced investors.

Key Features:

  • Open and closed-end funds are both collective investment funds ; the value of investments can go down as well as up and you may get back less than you invested.
  • OE funds issue and sell an unlimited number of shares to its investors
  • OE funds can be at risk of sudden inflows or redemptions
  • CE funds have a limited number of shares
  • CE funds can be purchased at a discount with large growth potential
  • Please do remember, the eligibility to invest in an ISA will depend on your individual circumstances, and all tax rules may change in the future.

Please do remember, the eligibility to invest in an ISA will depend on your individual circumstances, and all tax rules may change in the future.

The value of investments can go down as well as up and you may get back less than you invested.

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Source by Andrew Jenks

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