Risks of Closed-End Funds
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Risks of Closed-End Funds
Based on various factors, closed-end fund shares will either trade at a discount or a premium. But what happens to an investor’s money when the discount or premium begins to shrink?
Things To Know
- Liquidity is not a major risk of investing for most closed-end funds.
- Many closed-end funds have high volatility and increased risk.
If a discount begins to shrink, the investor actually makes money if he or she bought the share for a discount and it now sells at a premium.
There is more of a risk when buying at premium. If an investor buys a share at premium and the premium shrinks, the investor could take a major loss.
Volatility
Risks based on constant market price changes are known as volatility. Volatility measures the rate at which prices change. Because many closed-end funds invest in foreign markets or risky securities, many of them have high volatility and increased risk. However, volatility can also present more opportunities for investors to make profits from shrewd trading of changing discounts and premiums.
Liquidity risk
Liquidity risk is the risk that a market will not be able to place an order within a given period of time. Because most closed-end shares trade on the major exchanges, liquidity is not a major risk of investing for most closed-end funds. However, some funds investing in unique sectors or foreign markets trade only a few hundred shares a day.
Higher commissions
Closed-end funds do tend to have higher commissions than regular mutual funds. This is because the shares of the funds are fixed and can be bought only through the secondary market (unless they are new issues), instead of directly through the fund company.
A final word …
When considering close-end funds as an investment, evaluate the overall benefits and risks by doing your homework. Unlike open-end mutual funds, which provide investors with a prospectus, closed-end funds purchased on the secondary market have no such requirement. Do your homework before investing.