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Leveraging

In: Business and Management

Submitted By hayde93
Words 2744
Pages 11
Closed-End Funds

Understanding Leverage in Closed-End Funds
The concept of leverage seems simple: borrowing money at a low cost and using it to seek higher returns on an investment.
Leverage as it applies to a closed-end fund is more complex, and the landscape in which leverage operates has changed dramatically in the past few years. This makes it important for financial advisors and investors to refresh their understanding of leverage and leveraged closed-end funds.

LIKE ARCHIMEDES’ LEVER, leverage in an investment offers the opportunity to effectively magnify one’s initial input.

NOT FDIC INSURED

MAY LOSE VALUE

NO BANK GUARANTEE

Why are so many closed-end funds leveraged?
A closed-end fund is a publicly-traded entity that invests in a variety of securities, such as stocks and bonds. A closed-end fund raises capital by selling a fixed number of shares at one time through an initial public offering
(IPO). Once the initial capital is raised, the fund is “closed” and no longer directly offers its shares for sale. Instead, following its IPO, the fund’s shares trade on a secondary market, such as the NYSE or the NASDAQ. Unlike a typical mutual fund, closed-end fund shares are neither created nor redeemed depending upon investor activity, and thus have no impact on management of the underlying assets in the funds portfolio. This means the fund is better able to maintain a steady asset base.1
Because regulations limit the ratio of a fund’s leverage to its total assets, this expected relatively steady asset base makes managing to that ratio easier and more consistent, and makes applying leverage in a closed-end fund a generally sound decision. For this reason, leverage is generally more prevalent in closed-end funds than in other retail investment products.
About three-quarters of all closed-end funds use some form of leverage.

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