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Understanding closed-end fund structures
For many years, all closed-end funds (CEFs) were structured as perpetual funds, meaning they have no “maturity” or termination date. The introduction of CEFs with defined terminations — term and target term funds — has created additional opportunities for investors.
All closed-end funds (CEFs), regardless of their structure, have some basic features in common:
- They raise investment capital by offering a fixed number of shares through an initial public offering (IPO)
- Following the IPO, fund shares trade in the open market on an exchange.
- Investors can purchase fund shares during the IPO and/or after the IPO via the exchange.
The primary differences between perpetual, term and target term funds are the options available to investors looking to exit their fund investments and what they can expect to receive.
Because perpetual CEFs don’t have a termination date, shareholders looking to exit their investment sell their shares on the exchange at the current market price, which may be more or less than their purchase price.
Why consider a perpetual CEF?
Investors may choose a perpetual fund because they can remain invested in the fund until they decide to sell their shares. Given that the majority of CEFs today are perpetual, investors also have more choices when it comes to strategies and asset classes in which to invest.
A term fund has a specified termination date at which time the fund’s portfolio is liquidated. Investors who own shares when the fund terminates receive a cash payment equal to the NAV per share at that time. This NAV may be higher or lower than what the investor originally paid.
Why consider a term CEF?
Investors may prefer a term CEF because they have a specific investment time horizon that aligns with the fund’s termination date and know they will receive the NAV per share at that time. Since CEF NAVs tend to be more stable and predictable than prices set in the market, a term fund’s return of NAV can provide a greater level of price certainty than selling shares in the open market.
Target term funds
Like term CEFs, target term funds have a defined termination date. However, target term CEFs seek to return a specific, predetermined amount per share to shareholders when the fund terminates, rather than whatever amount the then-current NAV represents. At Nuveen, this amount is the NAV at the time of the IPO (“original NAV”).2 Therefore, shareholders who purchased their shares at the IPO expect to receive the same NAV per share that they originally paid. Shareholders who purchased shares after the IPO should also receive the original NAV, but that may be more or less than the price they paid for their shares.
Because one of the goals of a target term CEF is to return the original NAV to shareholders, the fund’s managers will manage the portfolio to help ensure sufficient assets are available at termination to meet this objective.3 For this same reason, bond strategies are more prevalent in target term as well as term funds because bond maturities can be more easily aligned to a fund’s termination date.
Why consider a target term CEF?
The appeal of target term CEFs is two-fold: the defined life of the fund which, like term funds, enables investors to plan to future investments or expenses, and the fact that shareholders know specifically what amount per share the fund is targeting to return. For shareholders who bought on the IPO, this amount is equal to their initial principal investment.
Featured closed-end funds
Funds have adopted one of three distribution approaches: income-only (IO), managed distribution (M), or level distribution (V). Historical distributions from managed distributions have included realized capital gains along with net investment income, and have also included a return of capital, representing unrealized gains or paid-in capital or both. Historical distributions under a level distribution or capital return plan approach have included a return of capital along with net investment income and may also include realized capital gains. It is important to understand these sources, and also the fund’s distribution rate relative to its NAV performance.
1 Although the fund has no specified termination date, it can be terminated upon notice to shareholders.
2 The objective to return the Fund’s original NAV is not an express or implied guarantee obligation of the Fund.
3 This typically includes limiting the fund’s investment to securities with maturities near that of the fund’s termination, and may include retaining a portion of the fund’s earnings which would reduce fund distributions prior to termination.
Important risk considerations
Closed-end fund shares are subject to investment risk, including the possible loss of the entire principal amount that you invest. Common shares frequently trade at a discount to their NAV. At any point in time, your common shares may be worth less than you paid, even after considering the reinvestment of fund distributions. Closed-end fund historical distribution sources have included net investment income, realized gains, and return of capital.