Most pooled funds transact at the value of their underlying holdings. Closed end funds do not, and the reason lies in how their shares are created and redeemed.
The share count is fixed at launch
A closed end fund raises capital once in a public offering and then closes. It does not continuously issue new shares or redeem existing ones at request.
An investor who wants in must buy from another investor on an exchange. An investor who wants out must find a buyer at whatever price the market offers.
That fixed supply is the structural difference. Open end mutual funds expand and contract with investor flows, while closed end funds hold a stable pool of capital.
Two prices exist at once
Net asset value is the per share value of the fund's holdings less liabilities, calculated from market prices at the close of trading.
The market price is whatever buyers and sellers agree to during the session, and it is quoted continuously like any other listed security.
When the market price sits below net asset value the fund trades at a discount, and when it sits above, at a premium. Both conditions can persist for long periods.
Why the gap opens and closes
Demand for the fund's strategy, its distribution rate, its expense ratio and the liquidity of its holdings all influence what investors will pay for the shares.
Sentiment matters more here than in open end structures because no arbitrage mechanism forces convergence. Nobody can create or redeem shares to capture the difference.
Exchange traded funds avoid this through an authorized participant process that creates and redeems baskets, which is precisely the machinery closed end funds lack.
Leverage is common in the structure
Because capital is stable, many closed end funds borrow or issue preferred shares to invest more than shareholders contributed, amplifying both gains and losses.
Borrowing costs move with short term rates, so a change in policy rates alters the fund's economics independently of what its holdings are doing.
Leverage also increases the volatility of net asset value, which in turn tends to widen the swings in the market price around it.
Distributions can include returned capital
Many of these funds emphasize a steady distribution, and the composition of that distribution is disclosed in periodic notices to shareholders.
Part of a payment may represent income earned and part may represent a return of capital, which reduces the investor's basis rather than reflecting earnings.
Reading those notices is a factual exercise that shows what a headline distribution rate actually consists of, and how it relates to the fund's underlying performance.