Brokers often sell their clients a new offering of a closed end fund. These are essentially mutual funds that have a limited number of shares which are not redeemed by the fund company but are sold like stocks on the secondary market. So, rather than redeeming your shares for their net asset value (like an open ended mutual fund), you must sell them at whatever the market value is. So, it can be more or much less than the actual net asset value of the investments the fund owns. More often than not, these funds historically tend to trade at a discount.
So, why should you avoid buying such a fund? Take a look at this chart of a relatively new closed end fund:
Source: CEF Connect
The fund is offered to you at $15 per share. Unfortunately, that includes 70 cents worth of money that goes to marketing and commissions rather than to investments in your fund. The underwriters of the fund often support the price for about a month (notice how things go well in the chart for about a month?). Then, price supports end and in most cases you see a decline begin towards the fund’s Net Asset Value. As funds typically trade below their net asset value (a topic for a future blog), the decline typically looks just like the one in this chart, with the price falling to below the Net Asset Value.
While we like many things about owning closed end funds, being an initial purchaser of a fund is not a good idea. Caveat Emptor! Anyone selling you such an investment should fully disclose how much they are receiving for the sale and explain why the purchase is justified in light of the history of these funds.