Why brokers ignore closed end funds

Given their attractiveness, it’s a wonder why brokers so rarely recommend closed end mutual funds. However, there’s a simple reason for this: while closed ends benefit individual investors, brokers benefit more by putting their clients in conventional, open-ended funds.

Closed end funds are a lot like conventional, open-ended funds. They hold a diversified portfolio of stocks, chosen by a fund manager who gets a fee for his or her services. The key difference is that open-ended funds stand ready to sell new fund units, or redeem existing fund units, on demand.

Closed end funds work with a fixed asset base, invested in a portfolio of securities. The value of their assets rises and falls, depending on how they invest. Their units trade like stocks, and mostly on a stock exchange.

Closed-ends may trade above their net asset value, or “at a premium,” as brokers say. But they mostly trade at a discount. If you buy them at a 10% discount, for example, and sell at the same discount many years later, you haven’t lost anything. But discounts on closed-ends sometimes shrink or disappear altogether. That happens when the funds liquidate, for instance, or convert to open-ended funds. But when that happens, you can earn a profit of 10%, 20% or more, virtually risk-free.

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In our Canadian Wealth Advisor newsletter, we spend a lot of time analyzing closed end funds. We do this because we think they give readers a number of attractive opportunities.

Brokers go where the money is

If a broker sells you a closed end mutual fund, they may charge you a 2% commission. (Individual brokers get to keep perhaps a third of the fees and commissions they bring in.) But the broker won’t earn another dime on that asset until you sell, possibly many years later.

On the other hand, if a broker sells you a conventional mutual fund, the broker can earn a steady stream of yearly trailer fees of 0.5% to upwards of 1.0%. Sometimes they get an immediate back-end load of up to 6% of your investment.

So you shouldn’t be surprised that brokers and brokerage-firm analysts respond to these incentives by favouring open end mutual funds over closed ends. These types of situations happen in many jobs and professions, not just brokerage.

To succeed as an investor, you need to stay alert for these conflicts of interest. You need to keep in mind that some brokers will resolve them by favouring their own interests over those of their clients.

In Canadian Wealth Advisor, we help you steer clear of brokers’ conflicts of interest. You also stay current on closed end funds and other investment bargains (and rip-offs, too), plus many other issues for safely making more money. Click here to learn more about Canadian Wealth Advisor.