Recently, a reader asked for clarification about the differences between Closed End Funds (CEFs) and Exchange Traded Funds (ETFs). The WSJ describes the features as follows:
“Both exchange-traded funds and closed-end funds are baskets of stocks, bonds or other investments that typically trade throughout the day on an exchange. Traditional mutual funds, in contrast, are typically priced just once a day at net asset value, which is the value of all fund assets minus liabilities, divided by the number of shares outstanding.
Since a closed-end fund sells a fixed number of shares that then change hands on an exchange, its market price is affected by demand for its shares and can drift far away from its NAV. So an investor who buys a closed-end fund at a price close to its NAV may ultimately sell at a price well above — or below — the value of the fund’s holdings.
But in an ETF, large investors can assemble a basket of securities that mimics the ETF’s portfolio and use this basket to buy big blocks of ETF shares. Likewise, they can sell a block of the ETF’s shares back to the fund in exchange for that basket of securities. Since big investors can easily swap ETF shares for the underlying securities, the ETF’s market price tends to stay close to its NAV.”
I have to add that when trading either, you always need to look at volume to make sure that your orders can get filled quickly whether you enter a trade or want to exit one. I have found that especially with lower volume municipal CEFs, liquidation can be very slow at times, and you may have to chase the market price, especially on down days.