Everybody likes a bargain, from after-Christmas shoppers to investors, which may explain the enduring popularity of closed-end mutual funds.
Unlike most mutual funds, they issue a set number of shares, which are bought and sold on stock exchanges. Their prices fluctuate during the day. And they rarely trade at actual value, selling instead for a discount of a few percentage points to more than 20 percent.
With about $250 billion in assets, estimates the Investment Company Institute, closed-end funds won't threaten the $7.9 trillion mutual-fund industry. But their sale prices have created a certain allure.
"We always buy at a discount," says Thomas Herzfeld, president of a money-management company specializing in closed-end funds in Miami. While he looks at other factors, including a fund's performance, management, and whether the investments are in favor, "at least half the decision is: What is the discount to net asset value, what is it relative to what the fund usually trades at, and what is it relative to its peers?" Mr. Herzfeld says.
Lately, closed-end income funds have been the most popular, he notes. In the current environment of low interest rates, investors looking for income have turned to funds that invest in corporate bonds, real estate investment trusts, dividend-paying stocks, and global bond funds.
Emerging-market funds have also been popular, which marks a return to the product's roots in the 1880s, when the British used them to invest in Argentina, Herzfeld says. "Then the Dutch opened closed-end funds to invest in Indonesia and the Philippines in the 1930s. That's one of the advantages of closed-end funds. They invest in smaller, illiquid markets."
Unlike the heads of open-end funds, managers of closed-end funds don't have to look for new investments whenever more money comes in. This lets them focus on smaller overseas markets where securities may not be traded as often.
Closed-end funds have a few other advantages over their open-end cousins, experts say. One of them is known as "managed distributions." All mutual funds distribute investment income - dividends, interest, and short-term capital gains - to investors. Open-end funds generally do this once a year. But many closed-end funds can do this each quarter, or even every month.
"People love managed distributions, especially retirees," says George Scott, president of Closed-End Fund Advisors, a Richmond, Va., investment firm. "They get a set distribution every quarter or every month." If a managed distribution option is available, it should be discussed in the fund's prospectus and sales literature.
Managers of closed-end funds also can use leverage to - they hope - generate higher returns, something else open-end funds don't usually do. Leverage involves borrowing money at short-term interest rates and investing the proceeds in longer-term securities that are expected to pay higher rates. That works as long as short-term borrowing rates are lower than the return on the fund's investments.
"If they get it right and the market's rising and the fund's making money, they're going to make about a third more than an unleveraged fund," Herzfeld says.
"Leverage can make gains bigger but it can also make losses greater," says David Kathman, a fund analyst at Morningstar Inc., in Chicago.
Finally, because they are continually traded on stock exchanges, closed-end funds can be bought or sold any time during the trading day at the latest available price. The sale price of an open-end fund is not set until after 4:00 p.m., Eastern time. This means an investor in a closed-end fund can take advantage of developments as they occur during the day.
There are some drawbacks. These funds are sold by brokers, which means paying commissions. Also, some investors don't like the fact that the discounts don't narrow after they buy these funds, even though the stocks or bonds in the portfolios may be doing well.
Still, "the fact that they're traded on an exchange means that they're more flexible than an open-end fund," Mr. Kathman says.