Will Closed End Exchange Traded Funds Completely Replace Open Ended Funds?

Most of you know that there is currently over $16 trillion worth of assets in the open end mutual fund industry with only about $2 Trillion worth of assets in the closed ended fund industry. What I am about to tell you might surprise a lot of you so please read carefully.  We are suggesting new purchases of only closed end exchange traded funds moving forward and no open ended mutual funds. The reason’s for this are many.

First, when a large customer sells an open ended mutual fund and if the seller is a large institutional shareholder, the fund company may be forced to sell shares of various positions at precisely the wrong time in order to pay off the selling institution. Closed end funds don’t have this problem since they are traded on an exchange and are immediately sold through the exchange to another buyer on a normal bid/ask spread without having to sell any of the holdings inside the fund.

Second,  the cost of closed end funds are considerably lower than opened funds. In some cases a little as one quarter of the cost of a similar open ended mutual fund.

Third, closed end funds are liquid intra day versus only end of day liquidity for open ended mutual funds. And in the current environment, a matter of minutes or hours can make all the difference.

Fourth, there tends to be much less style drift with closed end funds versus open ended funds as these vehicles tend to be more index oriented and more passive then actively traded open ended mutual funds. This reduced turnover in closed in funds also tends to reduce the ongoing internal transaction costs.

And lastly, most of you know that 80% of the open ended mutual funds don’t beat the S&P 500 Index.

For all of these reasons, our suggestions and models moving forward now include only closed end funds and no open ended funds. It is my belief that open ended funds will eventually be fully replaced by closed end funds for all of the reasons I have just mentioned.

To learn more about Edward McDonough, view his Paladin Registry profile.

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