One Big Difference Between Closed-End Funds And ETF’s

By: Pete
Date posted: 05.17.2012 (9:17 am) | Write a Comment  (0 Comments)

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There has always been a lot of confusion regarding the differences between Closed End Funds and ETF’s. There are a lot more ETF’s being traded but in some instances, the providers decide to go with Closed End Funds. Why? Let’s take the case of Sprott commodity funds that hold Gold or Silver. These funds go out and buy physical bars of gold and silver and then have to store those. It’s quite a process and as you can imagine, it’s not something that the fund wants to do every day.

Difference Between Close End Fund And ETF’s…

There is one big difference that you might not think is that important. For an ETF’s, brokers are able to create or “redeem” units. What does that mean? Imagine a bank like Citibank starts selling units of fund XYZ which are very popular. What would they do once they have almost none left.

ETF: Citi could contact the ETF issuer and buy a number of units at the actual value of the fund (NAV)

Closed End Fund: There would no way to buy from the issuer, Citi would thus need to buy more of the fund XYZ in the market but also sell less.

How would Citi pull that off? There is no magical solution. Citi would be forced to sell XYZ at a more expensive price. Eventually, for some very popular funds, the impact would be that all brokers would end up doing this and the fund XYZ could end up costing much more than the actual value of the fund, its NAV.

ETF’s > Closed End Fund

For investors, it’s much more advantageous to buy ETF’s that will generally trade much closer to what they’re worth. On ETF’s, many firms and market participants will do “arbitrage” where they buy or sell the ETF if it moves away from the NAV. For ETF’s with liquid underlyings, that ensures that they generally remain very close to the NAV at all times making it more predictable what investors will be able to get by trading them.

If I look at PHYS, the Sprott Physical Gold Closed End Fund, it had a NAV of $13.17 and closed at $13.80 (4.6% difference). That is a very significant difference.

Compare that to GLD, the Gold ETF which had a NAV of $153.08 and closed at $151.99 (0.7% difference)

Do you take into account the fact that a fund is closed end or if it is an ETF before buying shares? Or you do not care?

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