How do closed-end mutual funds work?
They are very much like mutual funds in that they are both investment companies. The difference between a mutual fund, which is also known as an open-end fund, and a closed-end fund involves the way they are priced and capitalized. Mutual funds have open-ended capitalization. They continually issue new shares to buyers and stand ready to redeem those shares when an owner of a mutual fund wants to dispose of his shares.
Closed-end funds, on the other hand, issue a fixed number of shares then trade on the stock exchange. So when a person buys shares in a closed-end fund he does so in a normal New York Stock Exchange transaction. The seller is an existing shareholder, not the fund issuing new shares, and when a seller of a closed-end fund wants out of a position he sells it in the open market to an investor who is buying in a normal stock market transaction rather than to the fund who is redeeming them.
What distinguishes a closed-end country fund?
They are formed with the investment objective of investing in a security of a single country. It is a traditional and historic way that investors have sought to invest in foreign markets. It dates back to the 1800s when the English were forming closed-end funds to invest in the Argentine Republic.
It’s a very efficient way to invest in a foreign market because, unlike mutual funds that have to continually issue new shares and meet redemption, closed-end funds have a fixed capital structure and therefore the portfolio manager can invest in illiquid securities. And in many of the countries these funds are formed to invest in stocks that are highly illiquid.
What are some risks associated with investing in closed-end country funds?
Exchange rates, political risks, foreign taxation issues, lack of disclosure. And in addition to those risks, the possibility that the closed-end fund discount would widen after the investor buys it. That’s a risk peculiar to closed-end funds. It’s also a potential benefit if a discount should narrow after he buys it.