New ETF Book by Larry Connors - Click here to read more
Confusion is prevalent in the investment community concerning the difference between Closed End Funds CEFs and Exchange Traded Funds ETFs. The upsurge in popularity of ETFs actually pushing them into the realm of the most heavily traded stocks; combined with the close similarities with CEFs has only added to the confusion. This article will describe the differences and similarities between ETFs and CEFs so you can make an informed decision about what instrument is best for you and your investment goals.
Let's start out by defining our terms. An ETF is a portfolio of stocks, bonds, options, and/or other instruments that trades as one stock on a stock exchange. They are designed to closely track a particular index, sector or group. The first ETFs were built to follow the S&P 500 and were called SPDRS (SPY | Quote | Chart | News | PowerRating). Next came the Nasdaq 100 tracking ETF, the QQQ's now QQQQ (QQQQ | Quote | Chart | News | PowerRating). The launch of these products was extremely successful triggering a myriad of literally 100's of ETF releases. Financial mad scientist types started designing ETFs that tracked practically everything from the price of gold (The Gold Shares SPDRS, GLD (GLD | Quote | Chart | News | PowerRating)) to small caps (the iShares Russell 2000 ETF, IWM (IWM | Quote | Chart | News | PowerRating)) to allowing you to leverage 3x short on the energy sector (Direxion Energy Bear 3X ETF, ERY (ERY | Quote | Chart | News | PowerRating)). And everything in between.
A Closed End Fund CEF and an ETF can appear very similar with just a cursory look, however they are actually very different. The term "closed" means that once the capital is raised for the fund, no more shares are available for investors. It is "closed" to new investment. Both ETFs and CEFs are traded on a stock exchange, contain a portfolio of instruments, and try to track a particular theme. Forms of closed end funds include sector equity funds such as Central Gold Trust, GTU (GTU | Quote | Chart | News | PowerRating), Gabelli Utility Trust, GUT (GUT | Quote | Chart | News | PowerRating), and DWS Global Commodities Fund, GCS (GCS | Quote | Chart | News | PowerRating), and often include exotic strategies like option arbitrage.
But this is where the similarities end. The primary differences for investors include the fact that ETFs are passively managed and CEFs are actively managed. In addition, the exact portfolio that makes up the ETF is public knowledge, whereas the ingredients in a CEF are normally not publicly known at all times. Awareness of what the fund contains is critical for institutional investors, as arbitrage opportunities can exist between the ETF and the underlying portfolio. This arbitrage forces the ETF to closely track the NAV of the underlying portfolio. CEFs do not contain this inherent control mechanism, therefore they rarely trade near their NAV making deep analysis difficult. In addition, there are a variety of taxation differences between CEFs and ETFs but taxes are beyond the scope of this article. My research indicates confusion still is rampant on the internet between these two products. An easy way to differentiate, when researching potential investments, is if the information contains the term "closed end" it is a CEF and not an ETF.
According to a recent report, eight out of ten securities traded are exchange-traded funds. Want to learn how to trade them? Click here to find out what traders are saying about Larry Connors' new book, Short Term Trading Strategies That Work: A Quantified Guide to Trading Stocks and ETFs!
David Goodboy is Vice President of Business Development for a New York City based multi-strategy fund.
Join the discussion on Twitter. Follow @Trading_Markets to leave your questions and feedback with the people you follow everyday at TradingMarkets.com.
Have something to say about the article you just read? Speak your mind on Twitter and let everybody join the discussion! Follow @Trading_Markets and leave your questions and feedback for the whole community. You can also join talk to us on Facebook by joining our fanpage.
About TradingMarkets | Contact | Advertise | Careers | Link to Us | Site Map | Help | Terms & Conditions | Privacy Policy | Return Policy | Testimonials | Feedback
The Connors Group, Inc. ("Company") is not an investment advisory service, nor a registered investment advisor or broker-dealer and does not purport to tell or suggest which securities or currencies customers should buy or sell for themselves. The analysts and employees or affiliates of Company may hold positions in the stocks, currencies or industries discussed here. You understand and acknowledge that there is a very high degree of risk involved in trading securities and/or currencies. The Company, the authors, the publisher, and all affiliates of Company assume no responsibility or liability for your trading and investment results. Factual statements on the Company's website, or in its publications, are made as of the date stated and are subject to change without notice.
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results of any individual trader or trading system published by Company are not indicative of future returns by that trader or system, and are not indicative of future returns which be realized by you. In addition, the indicators, strategies, columns, articles and all other features of Company's products (collectively, the "Information") are provided for informational and educational purposes only and should not be construed as investment advice. Examples presented on Company's website are for educational purposes only. Such set-ups are not solicitations of any order to buy or sell. Accordingly, you should not rely solely on the Information in making any investment. Rather, you should use the Information only as a starting point for doing additional independent research in order to allow you to form your own opinion regarding investments. You should always check with your licensed financial advisor and tax advisor to determine the suitability of any investment.
HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING AND MAY NOT BE IMPACTED BY BROKERAGE AND OTHER SLIPPAGE FEES. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.
The Connors Group, Inc.
10 Exchange Place, Suite 1800
Jersey City, NJ 07302
© Copyright 2009 The Connors Group, Inc.
