22.4.1 Structure Of Closed-end Funds

Closed-end funds represent a distinctive category of investment funds that are traded on stock exchanges. Here, we delve into their structure, trading dynamics, and unique characteristics.

Trading Mechanism

Once issued, closed-end fund units are listed on a stock exchange. Investors who wish to buy or sell units of the fund must do so through the stock exchange and pay a commission on the transaction. Unlike open-end funds, closed-end funds do not have front-end or back-end load fees.

Pricing Dynamics

The prices of closed-end funds are influenced by two key factors: market supply and demand and the underlying asset value. This can lead to different trading scenarios:

• Discount: Fund trades below its Net Asset Value per Share (NAVPS)
• Par: Fund trades at its NAVPS
• Premium: Fund trades above its NAVPS

Most closed-end funds historically trade at a discount to their NAVPS. To visualise this, consider the following formula:

$$ \text{Discount} = \left( \frac{\text{NAVPS} - \text{Market Price}}{\text{NAVPS}} \right) \times 100 % $$

A changing discount rate can be reflective of market sentiment. An increasing discount might suggest undervaluation, while a growing discount from historical norms could indicate underlying issues within the fund.

Key Indicators

Changes in the discount or premium levels of a closed-end fund can indicate various market sentiments or internal issues, such as:

• Disappointing investment strategy results
• Changes in management
• Poor performance by existing managers
• Increased management fees or expenses
• Extraordinary costs (e.g., lawsuits)

Underlying Assets

The assets in a closed-end fund may vary widely. Some common examples include:

• Preferred Shares: Particularly of Canadian financial institutions
• Diversified Holdings: Basket of foreign-based manufacturing companies
• Income-Producing Securities: Business trusts, real estate investment trusts (REITs), utility income trusts

Special Types of Closed-end Funds

Interval Funds (Closed-End Discretionary Funds)

These funds periodically buy back their outstanding shares, offering more liquidity than typical closed-end funds. They are more prevalent in the United States.

Termination Provisions

In Canada, some closed-end funds come with buyback or termination provisions. For instance, a fund might be structured to terminate on a specific date, like June 30, 2025. On this date, proceeds are distributed to unitholders. The fund manager, however, might propose continuation post this date, subject to unitholder approval.

Frequent Examples in Canada

Below is a Mermaid diagram showcasing popular structures and underlying assets of closed-end funds:

    flowchart LR
	  A[Closed-end Fund] --> B[Preferred Shares]
	  A --> C[Diversified Holdings]
	  A --> D[Income-producing Securities]
	  D --> E[Business Trusts]
	  D --> F[REITs]
	  D --> G[Utility Income Trusts]

Key Takeaways

• Closed-end funds are traded on stock exchanges, and transactions incur commission fees.
• The prices of closed-end funds are guided by market demand and asset values, leading to trading at discount, par, or premium.
• Persistent discounts below historical norms could signal problems in the fund’s strategy or management.
• A wide array of underlying assets can form the basis of closed-end funds.
• Special types such as interval funds and buyback provisions add specific nuances and flexibility.

Frequently Asked Questions (FAQs)

What determines the price of a closed-end fund?

Prices are influenced by the market demand and supply, as well as the net asset value of the fund’s underlying holdings.

What does it mean when a closed-end fund trades at a discount?

It means the fund is trading at a price lower than its Net Asset Value per Share (NAVPS). This could indicate potential undervaluation or underlying issues in the fund.

Are there any special closed-end fund structures?

Yes, interval funds periodically repurchase shares, and some closed-end funds come with buyback or termination provisions.

Where can I trade closed-end funds?

Closed-end funds are listed and traded on stock exchanges. Investors need to engage in transactions through these exchanges.