When most investors hear the word fund in relation to investment vehicles, their thoughts immediately head toward mutual funds. This isn't surprising as mutual funds are the option of choice for many investors seeking to gain exposure to the stock market. Mutual funds are fine investment choices, and their merits shouldn't be derided.

That said, if holding and monitoring individual equities isn't your cup of tea but you seek exposure to equities or fixed income investments, there is another compelling option available: Closed-end funds. Closed-end funds differ from mutual funds in that there are limited opportunities to participate. These funds offer investors shares that trade like stock, but there isn't likely to be multiple secondary offerings after the fund's initial public offering (IPO). The issued shares track the fund's performance.

While there are many mutual funds that track specific sectors or geographies, a large mutual fund, say one that manages $1 billion or more, is likely to hold dozens of stocks. A mutual fund that manages $20 billion may hold 50 or 60 or more stocks across many industries with no particular name accounting for too much of the fund's exposure. On the other hand, closed-end funds are usually more narrow. A typical closed-end fund really zeros in on a particular sector, securities group or country and is likely to own fewer securities than a traditional mutual fund.

These are actively managed funds and the performance of the held securities determines shareholder profit and loss. Let's delve deeper into the world of closed-end funds.

Is The Price Right?

One important aspect of closed-end funds for investors to note is how their price is calculated. A traditional mutual fund's price is computed once a day and all investors buying and selling that fund on any given day pay the same price. That price is known as the Net Asset Value (NAV).

Closed-end funds also have an NAV that is calculated at the end of the trading day, but it is not uncommon to see the share price of a closed-end fund differ from its NAV. If the shares are trading at a higher price than the fund's NAV, they trade at a premium and the fund may be overbought. Conversely, a fund with share price lower than its NAV trades at a discount and many experts would argue that closed-end funds that trade at substantial discounts to their NAV offer compelling opportunities for investors to pick up good assets on the cheap.

It is interesting to note that many closed-end funds have share prices that don't exactly mirror their and there really isn't a reason as to why this happens so frequently.NAVs

Advantages over Mutual Funds

Like mutual funds, closed-end funds often tout their diversified portfolios as one of their main selling points. A closed-end isn't likely to suffer too much if one or two of its holdings are performing poorly because the intent of closed-end funds is to spread market risk. Although mutual funds may hold a variety of stocks from a variety of sectors, a pessimistic market can be the fund's undoing because market risk can be concentrated in mutual funds.

That leads us to another point regarding what can fund managers do with languishing holdings. In a bad market, a mutual fund manager may have to sell shares of good stocks while holding some laggards so as to not to upset prices too much. A mutual fund manager may have a portfolio of millions shares of various stocks, but he can't go into the market and dump two million shares of his worst performer in one order. If he did, he'd drive the price down too far too fast and hurt himself in the process. Closed-end funds, on the other hand, are usually more nimble and can build and exit positions more efficiently.

Another advantage of closed-end funds is costs. Mutual funds have expenses such as management fees, loads and transaction costs. When you redeem your mutual fund shares, you'll get the NAV minus a percent or more of expenses. Since a closed-end fund trades like a stock, all you'll pay is your broker's commission.

Closed-end funds also use leverage to their advantage while other financial instruments become imperiled by it. Closed-end fund may issue preferred stock to investors to raise capital and as long as the interest rate on the loan and the dividend payout to preferred shareholders doesn't exceed the portfolio's performance, the fund is in good shape. That said, investors should be leery of closed-end funds with exceptionally high dividend yields as this is often a sign of too much leverage.

One more thing and this is sure to make investors without a lot of capital happy: There is no minimum investment with closed-end funds. A mutual fund may require investors to pony up $2,500 or more just to get in, but because closed-end funds trade like stocks, as long as you can afford one share, you can become a part of the fund.

Not As Popular As You Might Think

Given the noticeable advantages of closed-end funds over mutual funds, one would think they're just as popular. That's not the case as both mutual funds and exchange traded funds (ETF) dwarf their closed-end counterparts in sheer size. There is also a common misconception that closed-end funds are reserved for elite investors. Don't let either of these misnomers keep you away from closed-end funds. Your portfolio will thank you.