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The Trouble with Closed-End Funds

“Small investors are being scammed”, and their investments “absolutely massacred”. That’s the problem with closed-end fund investments, according to a recent MarketWatch article.

So far this year, buying into a closed-end fund IPO has proven to be a losing bet. Investors total losses stand at something like $1 billion.

The Closed-End Fund Association listed 13 fund IPOs through August: investors piled in over $5 billion, and they have now lost 22% of their money. But it’s not just the losses that are a problem. It’s the nature of these investments that warrants caution.

Closed-end funds are like mutual funds in that they are made up of a mix of assets, but they trade on an exchange like a stock. But, as the name implies, shares are not continuously sold, and only a set number of shares are issued in an IPO. Shares are not redeemable, meaning the fund is not required to buy them back from investors. That means these funds tend to be more illiquid than other investments…and a lack of liquidity makes them more volatile when the markets get rocky.

And the other problem is the cost. Typically, the first 5% of investors’ money goes straight to the broker. If you invest in an IPO at $20 per share, the broker will get $1…that means from the outset the value of your investment has fallen to $19. And after that, shares generally trade below their net asset value.

Firms typically push these investments when they are easy to sell… near the peak of the market. But that is not the opportune time for investors to buy; investors are better picking up shares at a discount.

This year’s performance aside, closed-end funds are best purchased only after some serious due diligence.


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