Target Employees: Closed-End Funds

Closed-end funds can be a good fit for Target 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.

'Target 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 Target 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. Target 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 Target 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 Target 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 Target 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 Target 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 benefits provided by Target Corporation's Personal Pension Account and Traditional Plan for employees approaching retirement, and how do these plans ensure financial security during retirement years? Understanding the synergy between these two plans is essential for retirees, as they work together alongside Social Security and personal savings to replace a portion of an employee's paycheck after retirement.

Key Benefits of the Personal Pension Account and Traditional Plan: Target Corporation's pension plan includes two components: the Personal Pension Account and the Traditional Plan. These plans work in tandem to replace a portion of an employee's paycheck during retirement. The Personal Pension Account provides pay credits and interest that accumulate over time, while the Traditional Plan uses a final average pay formula. Together with Social Security and personal savings, these plans help ensure financial security in retirement(Target Corporation_Dece…).

How can employees elect different payment options, such as the Single Life Annuity or the Joint and Survivor Annuities, within Target Corporation's pension plans? It is crucial for employees to grasp not only the financial implications of these choices but also the necessary spousal consent required when designating a joint annuitant, particularly if the chosen joint annuitant is not the employee's spouse.

Payment Options and Spousal Consent: Employees can elect different payment options, including the Single Life Annuity, which provides the highest monthly benefit and ceases at the retiree’s death, or the Joint and Survivor Annuity, which continues payments to a surviving spouse. To elect a non-spouse as a joint annuitant, spousal consent is required, and this must be notarized to ensure compliance with plan rules(Target Corporation_Dece…).

In what circumstances might benefits not be paid under the Traditional Plan, and what steps can employees take to ensure they remain eligible for their pension benefits upon termination of employment? Target Corporation's policy outlines several scenarios where benefits could be denied, making it necessary for employees to be proactive in understanding their rights and responsibilities concerning plan participation.

Circumstances for Denial of Benefits under the Traditional Plan: Benefits under the Traditional Plan may not be paid if an employee leaves before becoming vested (less than three years of service). Employees should ensure they meet the vesting requirements and maintain eligibility by avoiding termination before they reach the minimum service period(Target Corporation_Dece…).

What procedures should employees follow to report changes in marital status, address, or beneficiaries to ensure compliance with the requirements of Target Corporation's pension plan? Employees must understand the importance of timely reporting these changes to avoid potential issues with their retirement benefits and ensure that their pension plan information remains up-to-date.

Reporting Changes in Marital Status or Beneficiaries: Employees must promptly report changes in marital status, address, or beneficiaries to Target's Benefits Center to ensure their pension records remain up-to-date. Failing to do so can lead to delays or issues in processing pension benefits(Target Corporation_Dece…).

How does Target Corporation determine the final average pay used to calculate retirement benefits under its pension plans, and what factors may affect this calculation? Employees nearing retirement should be fully informed about how their compensation is considered in determining their pension benefits, including aspects such as bonuses and overtime that may influence their final average pay calculation.

Final Average Pay Calculation: Target Corporation calculates final average pay based on the five highest years of earnings out of the last 10 years of service. This includes regular pay, overtime, bonuses, and commissions but excludes items like workers' compensation or long-term disability payments(Target Corporation_Dece…).

How can employees begin the process of rolling over their Target 401(k) accounts into the Pension Plan, and what advantages does this Pension Purchase Program offer? Understanding this rollover option is vital for maximizing retirement benefits, as it can provide employees with a stable income stream while avoiding unnecessary fees typically associated with purchasing annuities outside the plan.

Rolling Over 401(k) into the Pension Plan: Employees can roll over their 401(k) accounts into the Pension Plan using the Pension Purchase Program. This option offers several advantages, including avoiding fees associated with purchasing annuities outside the plan and receiving a stable income stream during retirement(Target Corporation_Dece…).

What are the implications of a participant's age and joint annuitant's age on the payment amounts under the various Joint and Survivor Annuity options at Target Corporation? Employees should be aware of how age differences can impact their pension payouts, as the specific percentages payable under these options may vary based on the ages of both the participant and their designated joint annuitant.

Effect of Participant and Joint Annuitant’s Age on Payments: The Joint and Survivor Annuity options are influenced by the ages of both the participant and the joint annuitant. The younger the joint annuitant, the lower the monthly payout due to actuarial adjustments. Employees should consider these factors when selecting an annuity option(Target Corporation_Dece…).

How are retirement benefits managed during potential plan terminations or amendments at Target Corporation, and what protections are in place for employees in these scenarios? Employees should be well-informed regarding their rights in the event of changes to the pension plan, including how benefits would be distributed and under what circumstances they may remain fully vested.

Plan Terminations or Amendments: In case of plan terminations or amendments, vested benefits are protected, and employees will receive their earned pension. If the plan is amended or terminated, Target ensures that vested benefits are distributed according to the plan's terms(Target Corporation_Dece…).

For employees retiring or leaving Target Corporation, what options are available with respect to unused vacation time and how might this be factored into pension calculations? Understanding how accrued time off translates into benefits could have a significant impact on an employee's financial positioning upon retirement.

Unused Vacation Time and Pension Calculations: Unused vacation time does not directly affect pension benefits but can be included in eligible earnings calculations that determine final average pay. Employees nearing retirement should consult with Target’s Benefits Center to understand how unused time may impact their overall benefits(Target Corporation_Dece…).

How can employees contact Target Corporation for assistance with their retirement benefits to address any questions or concerns they may have about their pension plans? Accessing the right resources and support is essential for employees to navigate their retirement benefits effectively. They can reach out to the Target Benefits Center at 800-828-5850 for more specific inquiries related to their personal circumstances. These questions aim to enhance employees' understanding of their retirement benefits, ensuring they are well-prepared for their transition into retirement.

Contacting Target for Pension Assistance: Employees can contact the Target Benefits Center at 800-828-5850 for assistance with their retirement and pension plans. This center provides support with any questions related to pension options, payments, and administrative requirements(Target Corporation_Dece…).