CH 10 - 2 Differences between closed-ended and open-ended CISs

Question 1

2 Differences between closed-ended and open-ended CISs

1. Marketability

Answer 1

Closed-Ended Funds:
Shares may be less marketable than underlying assets (e.g., property investments, shares in small companies).
Can be more marketable if the assets themselves are unmarketable.

Open-Ended Funds:
Unit marketability is guaranteed by the fund managers.

Question 2

2 Differences between closed-ended and open-ended CISs

2. Gearing and Volatility

Answer 2

Closed-Ended Funds:
Can borrow funds (e.g., issuing loan capital), making shares more volatile but with potentially higher expected returns.
Example: Investment trusts with gearing can amplify both gains and losses.

Open-Ended Funds:
Limited or no gearing allowed.
Example: In the UK, unit trusts can borrow up to 10% of fund value.

Question 3

2 Differences between closed-ended and open-ended CISs

3. Discount to Net Asset Value (NAV)

Answer 3

Closed-Ended Funds:
Shares often trade below NAV (at a discount).

Discounts can vary:
1. Large discounts during periods when investment trusts are out of favor (e.g., after market downturns).
2. Narrow discounts when they regain popularity.

Opportunity: Buy when discounts are large and sell when they narrow to boost returns.
Open-Ended Funds:
Prices are directly tied to NAV; the concept of discounts to NAV does not apply.

Question 4

2 Differences between closed-ended and open-ended CISs

4. Volatility

Answer 4

Closed-Ended Funds:
Share prices are more volatile due to changes in discount size.
Example: Discount widening or narrowing impacts share price.
Open-Ended Funds:
Volatility of unit prices mirrors that of the underlying assets.

Question 5

2 Differences between closed-ended and open-ended CISs

5. Asset Valuation and Range

Answer 5

Closed-Ended Funds:
NAV may be uncertain, especially with unquoted investments.
Can invest in a broader range of assets compared to open-ended funds.
Open-Ended Funds:
NAV directly reflects the asset values with less uncertainty.

Question 6

2 Differences between closed-ended and open-ended CISs

6. Taxation

Answer 6

Tax treatment of closed-ended and open-ended funds may differ.

Question 7

2 Differences between closed-ended and open-ended CISs

7. Reasons for Discounts in Closed-Ended Funds

Answer 7

Management Charges:
Dividends paid to shareholders are reduced by management fees, lowering share value relative to NAV.
Marketability Concerns:
Smaller closed-ended funds investing in large company shares are less marketable than the underlying assets.
Management Quality:
Poorly rated investment managers reduce trust attractiveness.
Market Sentiment/Fashion:
Investment trusts may fall out of favor with investors, increasing discounts.

Question 8

8. Key Takeaways

Answer 8

• Closed-ended funds offer potential for higher returns but come with higher volatility and discounts to NAV.
• Open-ended funds provide stable pricing based on NAV and ensure unit marketability, making them less volatile.
• Discounts in closed-ended funds can be used strategically to maximize returns.