Today investors spend billions of dollars and conduct hours of research every day to look for valuable assets that will give them attractive returns.
While both Closed-end funds (CEFs) and Exchange-Traded Funds (ETFs) are popular financial products that can be purchased directly from exchanges, there is debate around ETFs vs Closed-end funds on which one of them makes a better investment idea.
It is important that investors know the advantages of both kinds of funds to make better decisions.
While a sound investment decision heavily depends on what an investor’s goal is and how much risk they will take, there are other factors that also need to be considered.
ETFs attract a lot of investors because they carry lower fees. Most ETFs also follow the general market trend. This makes investors feel an ETF is a good long-term investment opportunity than a managed mutual fund.
CEFs have a higher risk profile because they carry a fixed amount of stocks and are only available for trading over a short period. These funds can be bought from secondary markets as well at either a premium or a discount. They also carry higher fees when compared to ETFs.
This article will spell out some pros and cons of both types of funds.
The Popular ETFs Are Passive Funds
There are hundreds of thousands of ETFs that mostly track a major index in any market, such as the S&P 500 or the Dow Jones. For example, an ETF that follows S&P 500 will hold stocks that belong to that index and will move in the direction of the bellwether U.S. index itself.
It is very rare that an ETF would move against the general trend of the index that it is observing. ETFs also do not trade in the individual shares that are part of them. Any loss or gain that is seen in trading ETFs are due to market conditions and the fund never rebalances its holdings. The only time an ETF shifts balance is when a new asset is added or an existing one is removed from the fund.
CEFs Are Actively Managed Funds
Closed-end funds (CEFs), usually contain a small portfolio of securities, whether they are equities, debt, or any other asset class, of a specific sector, market, or country. a higher risk and higher expense ratios than ETFs, which make them more expensive to purchase.
CEFs, are bought and sold at either higher than the market value of their underlying securities (premium), or lower than that (discount). Therefore, the net asset value (NAV) of a CEF is not a very good pointer of its performance.
The value of a CEF only depends on investor demand and fund supply. If there is a selling pressure among investors of the CEF, the fund will trade at a discount, and it will trade at a premium in case of a buying pressure.
This means a CEF’s price could be substantially higher or lower than the value of its underlying assets. For example, the share price of a stock held in an equity CEF could be higher or lower than the stock’s market price quoted on the exchange.
These funds have lower transparency since the assets are actively managed and constantly traded. Fund managers can add and remove any security they feel fits the CEFs return goals and this can be done frequently throughout the trading cycle of the CEF. This increases the risk profile of the fund.
Today’s financial markets offer various choices for different investor goals. Whether investors pick ETFs or CEFs, they will have to conduct thorough research and read the relevant documents before deciding. Sound financial decisions require constant planning and no investment option will assure returns.
Both CEFs and ETFs will provide attractive returns if investors study their features before investing. However, more choices make it easier for investors since they have a range of options to pick from.
Savart is a SEBI-registered investment advisor, founded by Sankarsh Chanda. The purpose of this content is to educate, not to advise or recommend any particular security. Please remember that investments are subject to market risks. Please conduct thorough due diligence or seek professional guidance before making any investment. Do not believe in any speculations.