Federal securities laws categorize investment companies into three basic types:
1. Open-end companies;
2. Closed-end companies; and
3. Unit investment trusts (UITs).
In the case of open-end funds/companies, investors and fund companies buy and sell fund shares directly with one another.
There is no limit to the number of shares an open-end fund can issue, and additional shares are issued to meet investor demand.
Share prices are adjusted on a daily basis as required by federal regulation in a valuation process called “marking to market,” which bases the share price on the most recent changes to the portfolio (asset) value.
In the case of closed-end fund companies, on the other hand, shares are issued only once, in an “initial public offering.” Subsequently, the shares are listed for trading on a stock exchange.
While the number of shares is therefore independent from investor demand, share prices fluctuate accordingly, driven up by increased demand and the inverse. Thus, they often trade at (sometimes significant) premiums and discounts to their net asset value (NAV). In case you’re unfamiliar, net asset value, calculated each business day, represents the per-share value of a mutual fund or ETF and is based on the total value of assets (including stocks, bonds, cash, and other securities) in its portfolio less any liabilities (such as the manager’s salary and operating expenses) it may have, the difference of which is divided by the number of shares outstanding (owned by shareholders).
Investors cannot sell shares back to a closed-end fund; their only option is to sell them to fellow investors on a stock exchange.
Which Is More Common: Open- or Closed-End Companies?
Open-end fund companies are far more prevalent in number and asset holdings than the closed-end variety: In 2015, there were 8,116 open-end funds in the U.S. (comprising assets of $15.7 trillion), but just 558 closed-end funds (comprising assets of $261 billion), per the Investment Company Institute.
Unit Investment Trusts
Unit investment trusts (UITs), designed to provide capital appreciation and/or dividend income, issue redeemable securities, or “units”—redeemable meaning that the UIT will repurchase those units back from investors upon request, at the NAV.
Like closed-end funds, UITs issue only a limited number of units in a one-time public offering. However, investors have more leeway with UITs than with closed-end funds, as many UIT sponsors maintain a secondary market, which enables holders of UIT units to sell their units to those sponsors, who can then sell them to other investors.
Investors can purchase UITs from a broker typically at the relatively low investment cost of $1,000. They are provided with redeemable units and interest at the end of each quarter.
They have a limited lifespan, set when they are created. When a UIT terminates, investors receive its going price, which hinges on its then-current market value of its underlying securities.
Because UITs don’t have a board of directors, investment manager, or any type of active management, profits can be higher than they would be otherwise.
In 2015, there were 5,188 UITs in the U.S.