Closed-End Funds & UITs

These pooled investment vehicles have characteristics distinct from open-end mutual funds. Understanding their unique features is essential for the Series 65 exam.

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Closed-End Funds

Structure

Closed-end funds (CEFs) issue a fixed number of shares through an initial public offering (IPO), then trade on exchanges like stocks.

Key Characteristic: No Continuous Creation/Redemption

Unlike mutual funds:

• CEFs do not continuously issue new shares when investors want to buy
• CEFs do not redeem shares when investors want to sell
• Investors must buy from and sell to other investors on the exchange

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Premiums and Discounts

Since closed-end funds trade on exchanges, their market price can differ from their NAV.

Definitions

Example

A CEF has:

• NAV: $20.00 per share
• Market price: $18.00 per share
• Discount: ($18 - $20) / $20 = −10%

The fund trades at a 10% discount to NAV.

Why Do Discounts/Premiums Occur?

In Practice

Many CEFs persistently trade at discounts, which can create opportunities:

• Buy at discount = buy $1 of assets for less than $1
• But discounts can widen, causing losses
• Activist investors sometimes pressure funds to convert to open-end (eliminating discount)

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Closed-End Fund Features

Use of Leverage

CEFs can use substantial leverage to enhance returns:

Leverage Impact:

• Magnifies gains in rising markets
• Magnifies losses in falling markets
• Interest/dividend costs reduce returns
• Increases overall risk

Common CEF Strategies

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Unit Investment Trusts (UITs)

UITs are a unique type of investment company with a fixed, unmanaged portfolio and a set termination date.

Structure

How UITs Work

1. Sponsor creates trust with specific portfolio of securities
2. Units sold to investors at NAV plus sales charge
3. Portfolio held until termination (or bonds mature)
4. Income distributed to unit holders as received
5. At termination: assets sold, proceeds distributed

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Types of UITs

Fixed-Income UITs

Most common type:

Example: A 10-year municipal bond UIT buys 20 different muni bonds. As each bond matures, principal is returned to investors. When all bonds mature, the trust terminates.

Equity UITs

Common equity UIT strategies:

• Dogs of the Dow (highest-yielding DJIA stocks)
• Sector-focused portfolios
• Dividend-growth stocks

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UIT Pricing and Redemption

Pricing

Public Offering Price = NAV + Sales Charge (typically 1-5%)

Redemption Options

On the Exam

Key UIT characteristics to remember:

• Fixed portfolio: No active management
• Set termination: Not perpetual like mutual funds
• Self-liquidating: Trust dissolves at termination
• Lower costs: No ongoing management fees
• No board of directors: Unlike mutual funds

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Comparison: CEFs vs. UITs vs. Mutual Funds

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Key Takeaways

• Closed-end funds have a fixed number of shares and trade at market prices that may be above (premium) or below (discount) NAV
• CEFs commonly use leverage to enhance returns, increasing both potential gains and losses
• UITs have fixed, unmanaged portfolios that terminate on a set date
• UITs are self-liquidating: assets are sold and proceeds distributed at termination
• UITs have no board of directors or investment adviser after creation
• Both CEFs and UITs are registered under the Investment Company Act of 1940