Closed-end funds don’t share the same level of popularity as their mutual fund (or open-end) counterparts, and ETFs have probably overtaken closed-end funds in notoriety as well. We’re here to tell you that just because an investment strategy isn’t well-known doesn’t mean it can’t bring you good returns. Consider closed-end funds as an investment option that fills a gap somewhere between traditional mutual funds and ETFs. Closed-end funds are certainly not as liquid or volatile as most ETFs, but they are much more liquid than mutual funds.

Closed-end funds, which may surprise many to learn that they have been around for decades, are also prized by investors for their ability to generate income. On the other hand, ETFs and mutual funds, for the most part, seek capital appreciation. Knowing this, closed-end funds can be the icing on your diversification cake, acting as an ideal complement to ETFs and stocks.

How to distinguish closed-end funds from ETFs

If you’ve been following ETFs for even a short time, you’ve probably found that they’re pretty easy to understand. ETFs are essentially a basket of related securities designed to track the performance of those securities on a daily basis. While there are ETFs that track major indices like the Dow Jones Industrial Average and the S&P 500 (in fact, the first ETF was one that tracked the S&P 500), most ETFs focus on a particular market or sector niche. . For example, there are ETFs that focus on specific currencies like the Canadian dollar, and there are ETFs that track only one commodity like gold or oil. And when it comes to equity ETFs, just mention one sector and there’s probably at least one related ETF.

Equity ETFs own shares in a single sector. For example, the Oil Services HOLDRs ETF (OIH) only owns stocks that are considered oil service companies. On the other hand, the SPDR KBW Bank Index (KBE) tracks, you guessed it, banks. The narrow focus makes ETFs easy to distinguish.

With closed-end funds, stock offerings can be a bit more diverse. For example, it is possible to find a closed energy-related company that may have inventories of oil, coal, and natural gas. This can be a definite plus for investors looking for a little more diversification and an easy way to tell a closed-end fund from an ETF.

Another way to distinguish between these two investment vehicles is how they are traded. ETFs are easy to understand because they trade like stocks. The price of an ETF changes throughout the trading day just like a normal stock does. Closed-end funds don’t trade like that. They actually have two prices: their listing price and their net asset value (NAV). The NAV is used to track the fund’s holding value and it is possible for a fixed capital to trade at a premium or discount to the NAV. A closed-end fund that trades at a substantial discount to NAV can present an opportunity for investors to earn a good cash return at a discounted price, which is why many closed-end fund investors look for funds that trade below NAV.

Management Style: Another Key Difference

There is another big difference between ETFs and closed-end funds, and this can help you decide which one is the best fit for your investment system. ETFs are passively managed. This means that the holdings you hold in a particular ETF today will probably be the same a year from now, barring mergers and acquisitions, delistings, and bankruptcies. Closed-end funds, on the other hand, are actively managed. This means that if the fund manager wishes to remove one particular stock in favor of another, he is free to do so.

For the most part, this is an acceptable strategy for most investors. If a stock is a dog, you’d like to know that a fund manager is free to dump it, but the pitfall here is that as a fund manager moves in and out of various positions, the fund’s expenses increase. That’s not good news for fund shareholders because the expenses are passed on to investors. The bottom line is that ETFs have much lower expenses than closed-end funds.

Who is the big winner?

We’re not dodging the question, but the answer really lies in what type of investor you are. The liquidity, diversification and narrow sector exposure of ETFs make them an ideal choice for investors with shorter time horizons. Of course, we cannot ignore the ability of closed-end funds to generate income and actively manage their holdings. If you’re thinking of investing in a closed-end fund, consult a financial advisor to find the options that are best for you, and do some research on your own to ensure you find the fund that best suits your investment goals.