Chapter Five

US Closed-End Funds

Closed-end funds are one of four types of investment companies, along with mutual (or open-end) funds, exchange-traded funds (ETFs), and unit investment trusts. Closed-end funds generally issue a fixed number of shares that are listed on a stock exchange or traded in the over-the-counter market. The assets of a closed-end fund are professionally managed in accordance with the fund’s investment objectives and policies, and may be invested in stocks, bonds, and other securities.

What Is a Closed-End Fund?

A closed-end fund is a type of investment company whose shares are listed on a stock exchange or traded in the over-the-counter market. The assets of a closed-end fund are professionally managed in accordance with the fund’s investment objectives and policies, and may be invested in equities, bonds, and other securities. The market price of a closed-end fund share fluctuates like that of other publicly traded securities and is determined by supply and demand in the marketplace.

A closed-end fund is created by issuing a fixed number of common shares to investors during an initial public offering. Subsequent issuance of common shares can occur through secondary or follow-on offerings, at-the-market offerings, rights offerings, or dividend reinvestments. Closed-end funds also are permitted to issue one class of preferred shares in addition to common shares. Preferred shares differ from common shares in that preferred shareholders are paid dividends but do not share in the gains and losses of the fund. Issuing preferred shares allows a closed-end fund to raise additional capital, which it can use to purchase more securities for its portfolio.

Once issued, shares of a closed-end fund generally are bought and sold by investors in the open market and are not purchased or redeemed directly by the fund, although some closed-end funds may adopt stock repurchase programs or periodically tender for shares. Because a closed-end fund does not need to maintain cash reserves or sell securities to meet redemptions, the fund has the flexibility to invest in less-liquid portfolio securities. For example, a closed-end fund may invest in securities of very small companies, municipal bonds that are not widely traded, or securities traded in countries that do not have fully developed securities markets.

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Closed-End Fund Resource Center

Total Assets of Closed-End Funds

At year-end 2018, 506 closed-end funds had total assets of $250 billion (Figure 5.1). Total assets decreased by 9.8 percent from year-end 2017, largely driven by falling stock prices around the world.

Figure 5.1

Total Assets of Closed-End Funds Were $250 Billion at Year-End 2018

Billions of dollars, year-end

   

Note: Total assets is the fair value of assets held in closed-end fund portfolios funded by common and preferred shares less any liabilities besides preferred shares.
Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Historically, bond funds have accounted for a large share of assets in closed-end funds. At year-end 2008, 61 percent of all closed-end fund assets were held by bond funds, with the remainder held by equity funds (Figure 5.2). At year-end 2018, 64 percent of closed-end fund assets ($159 billion) were held by bond funds. The remaining 36 percent of closed-end fund assets ($91 billion) were held by equity funds. These shares have remained relatively stable, in part because of two offsetting factors. Over the past 10 years, cumulative net issuance of bond closed-end fund shares exceeded that of equity fund shares—offsetting the total returns on US stocks,* which exceeded those of US bonds during this time.

* As measured by the Wilshire 5000 Total Market Index.
As measured by the FTSE US Broad Investment Grade Bond Index.

The number of closed-end funds available to investors decreased in 2018, and remains well below its recent peak in 2011 (Figure 5.1). Over this period, more closed-end funds were liquidated, merged, or converted into open-end mutual funds or exchange-traded funds than were launched.

Figure 5.2

Composition of the Closed-End Fund Market by Investment Objective

Percentage of closed-end fund total assets, year-end

   

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

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The Closed-End Fund Market, 2018

Net Issuance of Closed-End Funds

Net issuance of closed-end fund shares was $597 million in 2018 compared with $570 million in 2017 (Figure 5.3). Bond closed-end funds had positive net share issuance of $1.0 billion—the vast majority of which was in domestic municipal bond closed-end funds. Equity closed-end funds, however, had net redemptions of $412 million in 2018.

Figure 5.3

Closed-End Fund Net Share Issuance

Millions of dollars

 Total Equity Bond
TotalDomesticGlobal/
International
Total Domestic
taxable
Domestic
municipal
Global/
International
2009 -3,259   -2,520 -2,366 -154   -739 -788 -238 287
2010 5,430 2,054 1,995 59 3,376 1,900 1,119 357
2011 6,018 4,466 3,206 1,260 1,551 724 825 2
2012 11,385 2,953 2,840 113 8,432 3,249 3,102 2,081
2013 14,515 3,605 4,097 -491 10,909 3,921 530 6,459
2014 4,935 4,314 3,819 494 621 266 567 -212
2015 1,829 1,267 224 1,043 562 678 -11 -104
2016 1,572 58 242 -184 1,515 1,437 576 -498
2017 570 -548 -147 -401 1,118 758 123 237
2018 597 -412 -352 -60 1,009 42 971 -4

Note: Net share issuance is the dollar value of gross issuance (proceeds from initial and additional public offerings of shares) minus gross redemptions of shares (share repurchases and fund liquidations). A positive number indicates that gross issuance exceeded gross redemptions. A negative number indicates that gross redemptions exceeded gross issuance.

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Closed-End Fund Distributions

In 2018, closed-end funds distributed $16.7 billion to shareholders (Figure 5.4). Closed-end funds may make distributions to shareholders from three possible sources: income distributions, including payments from interest and dividends; realized capital gains; and return of capital. Income distributions made up 67 percent of closed-end fund distributions, with a relatively even share paid by both equity and bond closed-end funds. Capital gains distributions accounted for 18 percent of closed-end fund distributions, and return of capital constituted 15 percent.

Figure 5.4

Closed-End Fund Distributions

Percentage of closed-end fund distributions, 2018

   

* Income distributions are paid from interest and dividends that the fund earns on its investments in securities.
Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Closed-End Fund Leverage

Closed-end funds have the ability, subject to strict regulatory limits, to use leverage as part of their investment strategy. The use of leverage by a closed-end fund can allow it to achieve higher long-term returns, but also increases risk and the likelihood of share price volatility. Closed-end fund leverage can be classified as either structural leverage or portfolio leverage. At year-end 2018, at least 332 funds, accounting for 66 percent of closed-end funds, were using structural leverage, some types of portfolio leverage (tender option bonds or reverse repurchase agreements), or both as a part of their investment strategy (Figure 5.5).

Figure 5.5

Closed-End Funds Are Employing Structural Leverage and Some Types of Portfolio Leverage

Number of funds, end of period

   

1 Components do not add to the total because funds may employ both structural and portfolio leverage.
2 Structural leverage affects the closed-end fund’s capital structure by increasing the fund’s portfolio assets through borrowing and issuing debt and preferred stock.
3 Portfolio leverage is leverage that results from particular types of portfolio investments, including certain types of derivatives, reverse repurchase agreements, tender option bonds, and other investments or types of transactions. Data are only available for reverse repurchase agreements and tender option bonds. Given data collection constraints, and the continuing development of types of investments/transactions with a leverage characteristic (and the use of different definitions of leverage), actual portfolio leverage may be materially different from what is reflected above.
Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

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Frequently Asked Questions About Closed-End Funds and Their Use of Leverage

Structural leverage, the most common type of leverage, affects the closed-end fund’s capital structure by increasing the fund’s portfolio assets. Types of closed-end fund structural leverage include borrowing and issuing debt and preferred shares. At the end of 2018, 282 funds had a total of $51.4 billion in structural leverage, with slightly more than half (54 percent) from preferred shares (Figures 5.5 and 5.6). The remaining 46 percent of closed-end fund structural leverage was other structural leverage, which includes bank borrowing and other forms of debt. The average leverage ratio* across those closed-end funds employing structural leverage was 28 percent at year-end 2018. Among closed-end funds employing structural leverage, the average leverage ratio for bond funds was somewhat higher (30 percent) than that of equity funds (24 percent).

* The leverage ratio is the ratio of the amount of preferred shares and other structural leverage to the sum of the amount of common assets, preferred shares, and other structural leverage.

Figure 5.6

Preferred Shares Constituted the Majority of Closed-End Fund Structural Leverage

Percentage of closed-end fund structural leverage, year-end 2018

   

1 A closed-end fund may issue preferred shares to raise additional capital, which can be used to purchase more securities for its portfolio. Preferred shares differ from common shares in that preferred shareholders are paid income and capital gains distributions, but do not share in the gains and losses in the value of the fund’s shares.

2 Other structural leverage includes bank borrowing and other forms of debt.

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Portfolio leverage is leverage that results from particular portfolio investments, such as certain types of derivatives, reverse repurchase agreements, and tender option bonds. At the end of 2018, 156 closed-end funds had $19.3 billion outstanding in reverse repurchase agreements and tender option bonds (Figures 5.5 and 5.7).

Figure 5.7

Use of Portfolio Leverage

Billions of dollars, end of period

   

Note: Portfolio leverage is leverage that results from particular types of portfolio investments, including certain types of derivatives, reverse repurchase agreements, tender option bonds, and other investments or types of transactions. Data are only available for reverse repurchase agreements and tender option bonds. Given data collection constraints, and the continuing development of types of investments/transactions with a leverage characteristic (and the use of different definitions of leverage), actual portfolio leverage may be materially different from what is reflected above.

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Characteristics of Households Owning Closed-End Funds

An estimated 3.6 million US households owned closed-end funds in 2018. These households tended to include affluent investors who owned a range of equity and fixed-income investments. In 2018, 95 percent of households owning closed-end funds also owned equity mutual funds, individual stocks, or variable annuities (Figure 5.8). Eighty-one percent of households that owned closed-end funds also held bond mutual funds, individual bonds, or fixed annuities. In addition, 53 percent of these households owned investment real estate.

Figure 5.8

Closed-End Fund Investors Owned a Broad Range of Investments

Percentage of closed-end fund–owning households holding each type of investment, 2018

Equity mutual funds, individual stocks, or variable annuities (total) 95
Bond mutual funds, individual bonds, or fixed annuities (total) 81
Mutual funds (total) 89
Equity 86
Bond  53
Hybrid  38
Money market  52
Individual stocks 70
Individual bonds 44
Fixed or variable annuities 45
Investment real estate  53

Note: Multiple responses are included.

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

Because a large number of households that owned closed-end funds also owned stocks and mutual funds, the characteristics of closed-end fund owners were similar in many respects to those of stock and mutual fund owners. For instance, households that owned closed-end funds (like stock- and mutual fund–owning households) tended to be headed by college-educated individuals and tended to have household incomes above the national median (Figure 5.9).

Nonetheless, households that owned closed-end funds exhibited certain characteristics distinguishing them from mutual fund–owning households. For example, households with closed-end funds tended to have greater household financial assets (Figure 5.9). Also, 37 percent of households owning closed-end funds were retired from their lifetime occupations, compared with 23 percent of households owning mutual funds.

Figure 5.9

Closed-End Fund Investors Had Above-Average Household Incomes and Financial Assets

2018

 All
US households
Households
owning
closed-end funds
Households
owning
mutual funds
Households
owning
individual stocks
Median
Age of head of household1 52 54 51 53
Household income2 $60,000 $125,000 $100,000 $113,000
Household financial assets3 $80,000 $500,000 $250,000 $400,000
Percentage of households
  Household primary or co-decisionmaker for saving and investing
  Married or living with a partner 57 63 70 69
  College or postgraduate degree 35 55 53 57
  Employed (full- or part-time) 62 65 76 72
  Retired from lifetime occupation 29 37 23 28
  Household owns
  IRA(s) 33 78 61 64
  DC retirement plan account(s) 48 70 84 72

1Age is based on the sole or co-decisionmaker for household saving and investing.

2Total reported is household income before taxes in 2017.

3Household financial assets include assets in employer-sponsored retirement plans but exclude the household’s primary residence.

Source: ICI Research Perspective, “The Closed-End Fund Market, 2018”

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A Guide to Closed-End Funds