ETFs vs Closed End Funds: What's the Difference?

Closed-end funds and ETFs trade on an exchange and enable investors to buy a portfolio of assets in one packaged security. But these two types of funds have many differences, as well as unique qualities, that investors should understand before choosing between the two. 

Learn the similarities and differences between ETFs and closed-end funds, as well as the pros and cons of investing in one fund type over the other. 

What Is an ETF? 

An ETF, which stands for “exchange-traded fund,” is an investment security that holds other investment assets, such as stocks or bonds. ETFs are pooled securities like mutual funds, but as the name suggests, ETFs trade similarly to stocks on an exchange. Most ETFs passively track a benchmark index, such as the S&P 500, while some are actively managed.

What Is a Closed End Fund? 

Closed-end funds, or CEFs, are portfolios of securities that pay out dividends and capital gains distributions, but, unlike ETFs, they can’t create or redeem shares on a daily basis. Instead, CEFs come to market through an IPO with a fixed number of shares. Like ETFs, CEFs trade intraday on an exchange, which means CEFs may trade at premiums or discounts to their net asset value (NAV). 

It’s important to note that a closed-end fund is not the same as a traditional mutual fund, which is a type of open-end fund. Most ETFs are structured as open-ended funds, but some may be structured as unit investment trusts (UITs). The main difference between open-end funds and closed-end funds is that an open-end fund can issue an unlimited number of new shares and is priced daily on its NAV, whereas closed-end funds issue only a fixed number of shares. 

ETFs vs Closed-End Funds: Similarities and Differences 

Comparing the similarities and differences between ETFs and closed-end funds is not the same comparison as ETFs vs mutual funds. ETFs and closed-end funds are similar in that they both trade intraday on an exchange. However, while many ETFs track the performance of an index of securities, closed-end funds are actively managed. 

How ETFs and Closed-End Funds Are Similar  

• Trading: ETFs and closed-end funds both trade during the day, at any time the stock exchanges are open.
• Pricing: Since ETFs and closed-end funds both trade in the secondary market, their market prices may trade at a premium or discount to their respective NAVs. Investors should note that a closed-end fund’s premium or discount is often more pronounced than most ETFs. 
• Dividends: Like many ETFs, closed-end funds may pay dividends on a monthly or quarterly basis. 
• Variety: As there are many types of ETFs, closed-end funds come in many varieties. 

How ETFs and Closed-End Funds Are Different  

• Structure: Unlike closed-end funds, most ETFs are structured as open-end funds and some ETFs are structured as UITs. 
• Creation/redemption: Unlike ETFs, closed-end funds don’t create or redeem shares. This is why the swings in market pricing can be more pronounced with closed-end funds. 
• Management style: Most ETFs are passively managed, whereas closed-end funds are actively managed.
• Fees: The passive management style of ETFs generally translates to lower expense ratios compared to the active management style of closed-end funds. 

What Are the Pros and Cons of ETFs vs Closed-End Funds? 

When comparing ETFs and closed-end funds, investors are wise to analyze the features and benefits of each, then use that information to weigh the pros and cons of investing in one versus the other. In the end, choosing between ETFs and closed-end funds is a personal choice.

Pros of Investing in an ETF vs a Closed-End Fund 

• Lower expenses: Since most ETFs are passively managed, they tend to have lower expenses compared to closed-end funds. 
• Greater price stability: For investors who prefer to buy or sell shares of a fund at a market price that is consistently near its NAV, ETFs provide more pricing stability than closed-end funds, which may trade at a market price further above or below its net asset value. 

Cons of Investing in an ETF vs a Closed-End Fund 

• Less discount pricing: Since closed-end funds have a fixed number of shares, they may sell at a significant discount to their net asset value, which provides potential for investors to profit. ETFs may trade at a discount to their NAV, but that is not as common or pronounced as closed-end funds.
• Potential for underperformance: Most ETFs are passively managed, which means they seek to track a benchmark index and will not outperform the benchmark. However, closed-end funds are actively managed, which enables the potential to outperform the market. 

Bottom Line  

ETFs and closed-end funds share some similarities, including the ability to trade intraday on an exchange. However, there are significant differences, such as management style and fees. Investors are wise to carefully consider their personal preferences and investing goals, as well as the pros and cons of ETFs versus closed-end funds, before investing.