Wall Street Potholes

Chapter 2Why Investors Pay Too Much for Yield

The Mysteries of Closed-End Funds

One of the persistent curiosities of investing is the inefficiency of the closed-end fund business. Closed-end funds have been around for decades. One of the very oldest, Adams Express (NYSE:ADX), claims it has been in continuous operation (Adams Express Company n.d.) since 1929, one of only five funds able to make such a claim. Nowadays, individuals trading their personal brokerage account can access the kind of technology and real-time analytics that used to be limited to large banks and brokerage firms. In so many ways, the financial markets are more efficient. And yet, closed-end funds continue to demonstrate inefficiencies as investors routinely do things that are widely recognized to cost them money.

Closed-end funds (CEFs) are similar to mutual funds in that they are specialized companies (Registered Investment Companies is the legal term) that own securities issued by other companies. Whereas mutual funds continuously issue and redeem shares to investors to balance supply and demand, CEFs have a fixed share count. When you invest in a mutual fund, you're issued new shares in the mutual fund company, which then goes into the market and invests your cash in more of the securities it already owns. By contrast, investing in a CEF means that you're buying some of the outstanding CEF shares in the open market from someone who already owns them.

This is why mutual fund transactions are done at ...