Closed-end funds can be a good fit for Alcoa employees looking for higher yields and diversification in their Retirement accounts - but you need to weigh the potential for higher returns against the risks with the help of an experienced advisor like myself - Wesley Boudreaux - of the Retirement Group, 'he said.
'Alcoa employees interested in closed-end funds should consider their investment goals and risk tolerance - consulting with a professional like Patrick Ray at The Retirement Group can help you sort through the maze of these funds.'
In this article we will discuss:
- 1. Closed-end funds - basics versus open-end funds.
2. The strengths and downsides of investing in closed-end funds.
3. Benefits of closed-end funds for income-seeking retirees in a low interest rate environment.
How Much Does a Closed-End Fund Cost?
Numerous Alcoa clients of ours ask about closed-end funds. An investment corporation called a closed-end fund pools funds from many different investors and invests them in stocks, bonds, and other securities. A fund generally issues a fixed number of shares and buys securities with the proceeds of an initial public offering (IPO). Its capital structure and number of shares are not yet known; the number of shares is fixed (this is why it is called closed-end). Every investor holds some of these holdings in shares.
Closed-end funds may be a good choice for retirees and pre-retirees who want regular income streams. Closed-end funds typically offer higher yields than traditional mutual funds because they are structured to invest in more assets such as real estate and commodities, according to a report by the Investment Company Institute (ICI) in 2021. Closed-end funds may also provide diversification and appreciation of capital. Retirees and pre-retirees should weigh investment goals and risk tolerance before investing in closed-end funds.
A fund's net asset value is its holdings value divided by the number of outstanding shares. Once it goes public, the fund trades on an exchange or the over-the-counter market just like any other security. A professionally managed closed-end fund can be diversified or non-diversified. Investing in the fund may also earn share price appreciation, dividend income and capital gains distributions if the fund sells individual securities at a profit during the year.
Closed-end funds - established in the nineteenth century - are often compared to mutual funds - more famous although younger - which are less well-known. The Investment Company Act of 1940 defines a closed-end company as 'any management company other than an open-end company' (such as a mutual fund). They are both categories of investment companies regulated by the Securities and Exchange Commission but have substantial differences. Alcoa employees might be curious about the differences and similarities of both types of funds.
Closed-end funds are much older than open-end mutual funds and there are far fewer of them; closed-end funds number in the hundreds, while open-end mutual funds number in the thousands. While a closed-end fund is different from an exchange-traded fund (ETF), there are some similarities our Alcoa could use understanding. A closed-end fund can invest like an open-end fund. But historically most closed-end funds were bond funds, the largest category being tax-exempt bond funds.
How Is a Closed-End Fund Different From an Open-End Fund?
And like most investment companies, a closed-end fund diversifies by investing in different securities. But we caution our Alcoa clients that diversification alone cannot deliver a profit or protect against loss. A closed-end fund also provides diversification but also professional management and a consistent investment objective. Like mutual funds, closed-end funds do not collect taxes at the fund level but pass those tax obligations onto shareholders.
The biggest difference between a closed-end and an open-end fund that we want our Alcoa clients to understand is that while an open-end fund must always be able to redeem your shares directly, most closed-end fund shares are traded on market exchanges and are generally not redeemed directly by the company issuing them. In a closed-end fund, the share count is set at the time of the IPO. Rather, an open-end fund issues and redeems shares daily-hence the name open-end-and the number of shares changes day to day - which affects the fund's net asset value (NAV).
Just like equities, closed-end funds move during the day - and their prices change throughout the day too. That is distinct from an open-end fund whose NAV is calculated only once per day after the markets close. If you want to sell your shares of a closed-end fund, the appetite of other investors to buy them will dictate how easy it is to do so and what price you will get.
Since closed-end funds trade on market exchanges, the market price of a share varies with market supply and demand. If demand exceeds supply, the market price for a closed-end fund's shares may be above its NAV, or net asset value, as the share is intrinsically valued. Demand may outstrip supply and closed-end fund shares may trade below their NAV. Some closed-end fund shares trade at a premium, most trade at a discount. This is not true of open-end funds, which will redeem your shares at NAV on the day you sell (or on the next closing day if you sell after 4 p.m.).
Joan buys 1000 shares of a closed-end mutual fund. She pays USD 14.50 a share. The NAV is USD 15.75. It amounts to Joan getting assets for USD 14,500. Joan sells her stock later for USD 16. She made USD 1,500 ($16,000 - USD 14,500) before transaction fees and commissions. Had she instead bought her shares at USD 16 and sold them at USD 14.50, Joan would have sold her portion of the fund for less than they were worth.
So how Is a Closed-End Fund Different from an Exchange-Traded Fund?
Some Alcoa clients wonder how closed-end funds differ from exchange-traded funds. Exchange-traded funds are much newer than closed-end funds. A closed-end fund may also technically be an exchange-traded fund. They both trade during the day on main exchanges. But today most ETFs are passively managed. The fund seeks to replicate a given index return as closely as possible. In turn, their market prices closely match the values of the securities in its portfolio, which track the index. Closed-end funds typically trade above or below their NAV.
Interval Funds
A closed-end fund that periodically offers its shareholders the ability to sell back some or all of its shares is called an interval fund. Shareholders notify the fund by a specified date if they want to accept the offer - usually every three to six months or annually - by that date. The actual repurchase will occur at a price determined by the fund's NAV on a specified date, usually shortly after the deadline for notifying the fund of a repurchase decision.
In contrast with many closed-end funds however, an interval fund possesses the characteristics of both closed-end and open-end funds. As with mutual funds, an interval fund might choose to maintain a price tied to the fund's NAV. And unlike many closed-end funds, shares of an interval fund can be priced daily. But because shares are not redeemed daily, the SEC classes them as closed-end funds.
The Strengths of a Closed-End Fund.
Shares in closed-end funds purchased at a discount represent some kind of leverage - the ability to profit both from rising values of the fund's holdings and from rising demand for the shares themselves. This leverage could boost your investment.
Some closed-end funds borrow money at relatively low cost and put it into higher-yielding securities. This can raise a fund's return if interest rates are falling or staying low. However, if interest rates go up or low-cost credit becomes unavailable, leveraged bond funds could underperform other bond funds that use no leverage.
A closed-end fund needs not hold cash for redemptions because it has a fixed number of shares. This capital may be used to try to increase investor returns. Because shareholders do not redeem shares directly, a manager need not sell assets to cover unexpected shareholder redemptions and can instead invest in less liquid securities.
A closed-end fund is not required to accommodate sudden inflows of capital from shareholders like an open-end fund does. Such unexpected inflows may require a fund to buy securities to invest the money - even if the manager thinks the market is expensive already; a closed-end fund manager has no such problem.
The board of directors for a closed-end fund might sometimes decide to convert the fund to an open-end structure. Suppose this happened, investors who bought shares at a discount to the NAV would profit from the difference between their discounted purchase price and the NAV of the new open-end fund.
Because closed-end funds are traded and priced throughout the day instead of just at the end of the business day, you control the price you pay when you sell and the timing of your sales.Closed-end funds have no minimum purchase requirements on the secondary market.It is because closed-end funds are traded on the secondary market; typically they have no marketing expenses like open-end funds do.
Tradeoffs with a Closed-End Fund.
A closed-end fund's market price may fall if investor demand decreases. Demand may decrease if the market perceives the fund or fund manager as bad or other market conditions exist outside of the fund. And the share price may drop despite the fund manager making smart investments and increasing the fund's asset value.
More closed-end funds can invest in illiquid securities than mutual funds - which can be problematic if the fund manager must sell the securities. An illiquid security generally is one that cannot be sold within seven days at the approximate price the fund uses to calculate NAV.
Because leverage magnifies losses as well as increases return, a closed-end fund that uses leverage might underperform an unleveraged fund when its strategy does not work as expected - for instance if interest rates rise or cheap credit contracts become available - as in a credit crisis. Buy-sell agreements could increase losses; if investor demand is down, your shares will drop too.
Even if the fund manager does a good job and the fund's assets appreciate in value, lack of investor demand could cause the fund's market price to drop below your purchase price and the fund's NAV. The fact that they trade at a premium or discount means closed-end funds can be more volatile than their open-end counterparts.If the board of directors issues new shares by way of a rights offering that would dilute the value of the existing shares, the fund can increase its capital.
A closed-end fund is exposed to the same market risks as any fund that invests in stocks or bonds - for instance, the risk that a bond will default, prepay or be called early; a company will go bankrupt; and that interest rates, inflation, credit availability, political or economic conditions, and/or currency risks will affect the fund's holdings.
Closed-end fund performance is less readily available than open-end fund performance. They are sometimes also less liquid.
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You buy a ticket to a limited-time show by investing in closed-end funds. A closed-end fund has a fixed number of shares just like a theater production has fixed seats. Those shares are sold and the show/fund is closed to new investors. Just as a popular play might draw huge crowds for tickets, a successful closed-end fund might draw significant investor interest and potentially better returns. Just as some shows are better than others, you should research and choose a closed-end fund that meets your investment goals and risk tolerance, however.
Added Fact:
A new study from Morningstar published in April 2023 concluded that closed-end funds could be a good fit for income-seeking investors at low interest rates. The study said closed-end funds that focus on high-yield bonds and dividend-paying stocks historically have offered higher yields than open-end mutual funds. This is especially useful for 60-something investors who want regular income streams in retirement. Open-end funds may provide better yields and diversification benefits than traditional retirement investments. (Source: Morningstar, April 2023)
Added Analogy:
Closed-end investing is like joining an elite club with a finite number of memberships. Like the club that gives members special privileges and amenities, closed-end funds offer investors a broad spectrum of investments. Every membership gets a piece of the fund's holdings, with potential gains for investors. As different clubs serve different interests, so too must investors research and select closed-end funds that meet their financial goals and tolerance for risk. Selecting the right 'club' or closed-end fund can provide income generation, potential capital appreciation and diversification for retirees and pre-retirees.
Sources:
1. Reaves Asset Management. 'Retirees: Keep Your Eyes on Income with CEFs.' Reaves Asset Management, https://insights.reavesam.com/blog/retirees-keep-your-eyes-on-income-with-cef?utm_source=chatgpt.com .
2. Investopedia. 'Closed-End vs. Open-End Investments: What's the Difference?' Investopedia, https://www.investopedia.com/ask/answers/042315/what-are-primary-differences-between-closed-end-investment-and-open-end-investment.asp?utm_source=chatgpt.com .
3. InvestmentNews. 'Why Anxious Retirees Should Consider Closed-End Funds.' InvestmentNews, https://www.investmentnews.com/retirement-planning/why-anxious-retirees-should-consider-closed-end-funds/222196?utm_source=chatgpt.com .
4. BlackRock. 'Five Reasons to Consider Closed-End Funds in Your Portfolio.' BlackRock, https://www.blackrock.com/us/individual/education/closed-end-funds/insights/reasons-to-use-closed-end-funds?utm_source=chatgpt.com .
5. Financial Planning. 'Closed-End Funds: From All Angles.' Financial Planning, https://www.financial-planning.com/news/closed-end-funds-from-all-angles?utm_source=chatgpt.com .
What are the key eligibility requirements for employees to participate in the Pension Plan for Certain Hourly Employees of Alcoa USA Corp, and how do these requirements change if an employee is hired or rehired after April 1, 2022? This question aims to explore the specific criteria that must be met for participation in the plan, providing clarity on both the general eligibility for new employees and any exceptions for those previously employed.
Eligibility Requirements: Employees are automatically eligible for the Pension Plan for Certain Hourly Employees of Alcoa USA Corp if they were hired or rehired before April 1, 2022, have reached age 21, and completed one year of vesting service. Employees hired or rehired on or after April 1, 2022, are not eligible for this pension plan(Alcoa USA Corp_Pension …).
How is the vesting service calculated in the context of the Alcoa USA Corp pension plan, and what implications does it have for an employee considering retirement? Understanding the nuances of how vesting service is accrued and the minimum time required to become vested can significantly impact an employee's retirement planning.
Vesting Service Calculation: Vesting service determines when an employee becomes eligible for pension benefits. Employees become vested after completing five years of vesting service, which includes both periods of pension service and non-pension service such as absences not counted towards pension service. This is crucial for retirement planning, as it ensures employees are entitled to pension benefits even if they leave the company after becoming vested(Alcoa USA Corp_Pension …).
What various retirement options are available to employees of Alcoa USA Corp, and how do these options affect the benefits and payout structure for retiring employees? This question addresses the multiple choices employees face when planning their retirement, including the differences between normal retirement, early retirement, and disability retirement benefits.
Retirement Options: The plan offers normal retirement (at age 65 with five years of vesting service), 60/10 retirement (for employees between 60 and 62 with 10 years of vesting service), and 62/10 retirement (for employees between 62 and 65 with 10 years of vesting service). Disability retirement is also available for those permanently incapacitated with 10 years of vesting service(Alcoa USA Corp_Pension …).
Can you elaborate on the survivor benefits provided under the Alcoa USA Corp pension plan, and what steps need to be taken to ensure that a spouse or partner is eligible for these benefits upon the employee's retirement? This question seeks to examine the protections and financial security afforded to survivors, alongside the required documentation and choices available to employees.
Survivor Benefits: The pension plan provides automatic surviving spouse coverage unless waived by the employee and spouse. Surviving spouse pensions are payable if the employee dies while actively employed and vested in the plan, after retirement, or while receiving a deferred vested pension. The spouse must submit a written application to claim benefits(Alcoa USA Corp_Pension …)(Alcoa USA Corp_Pension …).
What are the specific methodologies used to calculate the regular monthly pension for employees retiring under the Alcoa USA Corp pension plan, and how might these calculations vary based on an employee's age and years of service? This question looks at the complex actuarial factors that influence pension benefits, enhancing employees' understanding of how their retirement income is determined.
Pension Calculation: The regular monthly pension is calculated using a formula based on the employee's pension service and a pension factor in effect when pension service ends. For example, if an employee retires at 65 with 10 years of service, the pension factor might be $57 per year of service. The pension is adjusted based on age and service length(Alcoa USA Corp_Pension …).
In the event of a disability, how does the Alcoa USA Corp pension plan provide support to affected employees, and what are the requirements to qualify for disability retirement benefits? This question emphasizes the importance of understanding disability provisions, ensuring employees are aware of their rights and the circumstances under which they might qualify for benefits.
Disability Retirement: Employees under 62 who are permanently incapacitated with at least 10 years of vesting service qualify for disability retirement. They must be deemed permanently disabled and unable to return to work in a bargaining unit occupation. A medical examination may be required to confirm ongoing eligibility(Alcoa USA Corp_Pension …).
What steps must Alcoa USA Corp employees take to apply for retirement benefits, and what timelines are involved in the processing and payout of these benefits? This question delves into the procedural aspects of retirement applications, aiming to prepare potential retirees for the necessary actions they must undertake.
Retirement Application Process: Employees must file a retirement application with the plan administrator before their desired retirement date. The application can be filed up to 90 days before retirement, and the process typically includes receiving benefit explanations and payment elections within this timeframe(Alcoa USA Corp_Pension …).
How does the Pension Benefit Guaranty Corporation (PBGC) influence the pension benefits received by employees of Alcoa USA Corp, particularly in the context of plan terminations or financial challenges? This question explores the security provided by the PBGC, focusing on its role as a backup for employees’ pension benefits.
Pension Benefit Guaranty Corporation (PBGC): The PBGC provides a safety net for pension benefits in the case of plan termination or financial distress. If the pension plan is underfunded, the PBGC ensures employees still receive pension benefits, although certain limitations may apply(Alcoa USA Corp_Pension …).
What resources and support does Alcoa USA Corp provide to its employees for understanding their pension plan, and how can employees reach out for assistance regarding their retirement options? This question emphasizes the resources available to employees for further education and guidance, ensuring they know where to turn for help.
Resources for Understanding the Plan: Employees can access information about their pension plan and retirement options through the Alight Worklife™ website or by calling the Alcoa benefits helpline. These resources offer guidance on applying for retirement and understanding plan benefits(Alcoa USA Corp_Pension …).
How can employees of Alcoa USA Corp contact the benefits management team to learn more about their specific pension plan details, and what channels are available for inquiries? Understanding the communication channels can empower employees to seek the information they need, facilitating a smoother transition into retirement.
Contacting Benefits Management: Employees can reach out to the benefits management team through the Alight Worklife™ website or by phone at 1-844-31ALCOA. This service provides assistance with pension-related inquiries and retirement applications(Alcoa USA Corp_Pension …).
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