Pooled investments like mutual funds and ETFs are convenient vehicles through which investors can attain diversified exposure to various asset classes. But one particular type of fund has been around since the Civil War and yet is little understood, even by many individual investors that own them: closed-end funds.
As with traditional open-end mutual funds, closed end funds offer investors the opportunity to own a basket of securities like stocks and bonds. But due to their somewhat unique structure, CEFs are more complex and require a deeper understanding before being added to a portfolio. The behavior of these funds depends upon more than just the performance of the securities within.
Some of the very first investment pools available to individuals were closed end funds. British investment trusts became popular in the early 1860s in the financing of American railroads. In 1893, investors were offered shares in the Boston Personal Property Trust, the earliest example of a US fund. By the time of the Great Depression, investment trusts dominated the landscape and in fact played a seminal role in the stock market crash of 1929, thanks to extreme valuations and excessive margin debt. Regulatory actions in the 1940s addressed some of the riskier aspects of CEFs to make them more suitable for individual investors.
Following the great crash, interest in investment trusts or closed-end funds waned but has resurged in recent years, particularly as low interest rates have prodded investors to seek higher yields.
Two factors make closed-end funds different and more complicated than other types of funds: their fixed-share construction and the use of leverage.