Closed-End vs. Open-End Investments: What's the Difference?

Closed-End vs. Open-End Investments: An Overview

Closed-end funds have a fixed number of shares issued by the fund; open-ended funds do not have a limit on the number of issued shares. However, the primary differences between the two lie in how they are organized and how investors buy and sell them.

Both are professionally managed funds that achieve diversification by investing in a collection of equities or other financial assets rather than in a single stock. Additionally, they both pool the resources of many investors to invest on a larger and wider scale.

Closed-End Investments

A closed-end investment is overseen by an investment or fund manager and organized in the same fashion as a publicly traded company. This type of fund offers a fixed number of shares through an investment company, raising capital through an initial public offering (IPO). After the IPO, shares are listed on an exchange. Investors can purchase shares through a brokerage firm on the secondary market.

Closed-end funds can be traded at any time of the day when the market is open. They can’t take on new capital once they have begun operating, but they may own unlisted securities in the U.S. Investors should know that there are also interval funds—a type of closed-end fund—that do not trade in the secondary marketplace.

The nature of each type of fund also affects how it is priced. Closed-end investment shares reflect market values rather than the net asset value (NAV) of the fund itself. That means they can be purchased or sold at whatever price the fund is trading at during the day. Demand is what drives share prices. Since market demand determines the price level for closed-end funds, shares typically sell either at a premium or a discount to NAV.

Closed-end funds are more likely than open-end funds to include alternative investments in their portfolios, such as futures, derivatives, or foreign currency. Examples of closed-end funds include municipal bond funds. These funds try to minimize risk by investing in local and state government debt.

There are several possible areas where distributions come from in closed-end funds. These can come from dividends, realized capital gains, or interest from fixed-income assets held in the funds. The fund company passes the tax burden on to shareholders, issuing them a form 1099-DIV with the breakdown of distributions every year.

Open-End Investments

If you hear the term open-end fund and think of a mutual fund, you won't be entirely wrong. That's because a mutual fund is one type of open-end fund. Other types of open-end investments include hedge funds and ETFs. These are offered through fund companies, which sell shares in each directly to investors. Outside the U.S., open-end funds can take the form of SICAVs in Europe and OEICs or unit funds in the U.K.

Open-end funds are traded at times dictated by fund managers during the day. There is no limit to how many shares an open-end fund can offer, meaning shares are unlimited. Shares will be issued as long as there's an appetite for the fund. So when investors buy new shares, the fund company creates new, replacement ones.

Prices for open-end funds are fixed once a day at their NAV and reflect the fund's performance. This value is the fund's assets minus its liabilities. This is the only price at which fund shares can be purchased that day.

Some open-end funds may charge investors a fee occurring when shares are purchased or when they are sold. A front-end load is a fee or commission charged when an investor initially purchases shares in the fund. This is a one-time charge and is not incurred as an operating expense. The back-end load is a fee charged to investors when they sell shares in mutual funds. The fee amount depends on the value of the shares being sold, usually charged as a percentage. Other open-end funds will not charge investors a fee at all. These are known as no-load funds.

Open-end investments, such as mutual funds, do not pay taxes themselves but pass on the taxes to their investors. This means investors pay taxes on any capital gains or income derived from these funds.

Closed-End vs. Open-End Example

An example of a closed-end fund is the BlackRock Income Trust (BKT). This fund had an IPO date of July 22, 1988, and was launched as an attempt to preserve capital and provide a high monthly income for investors.

The fund's shares are traded on the New York Stock Exchange. It has more than $335 million in assets under management and 21.3 million shares outstanding. As of June 20, 2024, BKT was trading at a discount of -2.96%. It had a current monthly distribution per share of $0.0882. The fund has 161 holdings and a market price of $11.82. To achieve a monthly income of $882, you'd have to buy 10,000 shares for $118,200 on June 20, 2024.

BlackRock's iShares S&P 500 Index Fund (BSPIX) is an open-ended fund with just under $42 billion in assets under management on June 20, 2024. This fund tracks the S&P 500 Index and has a net expense ratio of 0.01%. It holds the stocks of 504 companies and is open to new investors, who can purchase shares through a broker. Gains are made by increases in a share's market price. On June 20, 2024, the fund had a one-year return of 29.85%, a five-year return of 15.04%, and a 10-year return of 12.94%.

The Bottom Line

An open-end fund does not have a fixed number of shares but allows investors to purchase shares continuously at market value. A closed-end fund is generally a one-time offering to investors. These shares can be traded on the market and are often traded at either a premium or discount to the shares' market value.