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Closed-end funds are mutual funds that issue only a limited number of shares for public trading. The trading price of a mutual fund set up as a closed-end fund is often influenced by the supply and demand for the shares outstanding. This is in contrast to other mutual funds that tend to trade based on the net asset value of the underlying security. The conditions of the fund are usually announced at the time of the initial public offering.
Because the price associated with a closed-end fund is dictated mainly by the market price, the competition for these types of funds can become quite fierce. The additional incentive has to do with the limited availability of the shares. Since only a limited amount of shares are made available for public trading at any given time, investors who consider the closed-end fun to be highly desirable may actively compete to secure the shares. This will often drive up the market price that the shares can command.
Understanding the performance of a closed-end fund is key to determining if attempting to secure the shares is a good idea. When the prices for the shares is consistently above the net asset value of the underlier, the fund is understood to be trading at a premium. If market indicators forecast that the market price will continue to rise, the acquisition of the shares is recommended.
At the same time, if the shares are selling at less than the net asset value, the fund is said to be trading at a discount. Before choosing to assume the discounted price is worth taking advantage of, the investor should look more closely at the closed-end fund. If there are indications that the shares will shortly begin to command a price that is above the net asset value, then acquiring the shares now is a good move. On the other hand, if the shares involved in the closed-end fund are not anticipated to rise in market value within an acceptable period of time, the investor may want to seek opportunities elsewhere.
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