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Closed-end mutual funds | Finance & Capital Markets | Khan Academy - YouTube
Channel: Khan Academy
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In the last video we had Pete starting an open-ended mutual fund
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that was managed by Pete Inc.
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Mutual Funds normally have nice grand names
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maybe they called this the Saturn Fund
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and if there is a Saturn Fund out there, I just picked that name at random
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I'm not implying that this is you or anything like that
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I just made up that name on the fly
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But it's managed by Pete Inc. and we called it an open-ended fund
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because at any time one of the people who owned a share
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or unit in the fund can redeem it back from the fund
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that Pete or the management company would say
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If you want your $180 back we'll buy that
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we'll give you $180, you give back the share, and then we cancel the share
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and if anyone wants to add to the fund
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if they want to invest
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the corporation can create new shares
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and then issue it to people - sell it to people
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and their money would go into the common pool
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and the management company would take fees off of it
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But that probably had you asking
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If this is an open-ended fund, what is a closed-ended fund
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or do they even exist?
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And they do
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That's what I'm going to talk about here
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Closed-end funds
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and closed-end funds on some level are a little bit simpler
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What happens in a closed-end fund is that
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all of the investors are essentially
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Or I guess you can say that the share structure
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is locked from the beginning
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So if Pete wanted to start a closed-end mutual fund
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he would once again register a corporation with the SEC
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he would market it it
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he would tell everyone "Hey I'm Pete, I'm an awesome investor"
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"Here's my track record"
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and then he would just get a bunch of investors
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so lets say he's able to find 20 investors
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and that's all he's able to find
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so this is 20 right here, and I'm not going to count
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but, let's say that there's 20 slices right over here
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He gets 20 people, so let's say they each give $100
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so he is able to raise $2000. 20 times $100
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So he is able to raise $2000
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And once that happens, the fund is closed.
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Pete's going to do his best to manage this
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So Pete will manage this and he will still take a management fee
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Maybe the same 1%
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But what's fundamentally different here
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and he can market - well he doesn't have to market the fund anymore
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because he can no longer get new investors
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and this is actually the main difference
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An open-ended mutual fund
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at any point in time
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or I should say at the end of trading
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at the end of a day, they can lose investors, or they can gain investors
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so it's an incentive for an open-ended fund
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to constantly market itself
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because the manager wants to manage more money
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so that he gets more of a management fee
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And a closed-end fund
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They'll market it right when they are creating the fund
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But once they create it
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So lets say he just got his 20 investors
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Then it is closed
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He can't create any more shares
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or cancel any more shares
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But what can happen
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so you might say
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well in a closed-end fund
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How do these people let's say you're holding
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one of these shares
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let's say that you're holding one share
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right over here
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what happens if you want to
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If you need to buy a house, or if you owe money to somebody
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so you want to get the value of your share back
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and the answer with a closed-end fund
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is that you would then go sell your share to someone else
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so this right here you can trade it
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You can trade it
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and you would trade it just you would
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trade the stock of any company
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And in fact when you go and buy or sell
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a stock of IBM, most of the time
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you're just buying or selling it from someone else
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You're not transacting with IBM
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the company
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You're trading in the secondary market
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you're not dealing with the actual corporation
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so that's where the investor
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get's their liquidity
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and when we say liquidity
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it allows them to convert it into cash
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because they can trade it
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So the big difference
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open-ended fund: when an investor wants their money back
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they have to deal with the fund itself
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the fund will buy back their share
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If some wants to invest in a fund
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the fund will sell them the share
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so they're always dealing with the fund itself
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in a closed-end fund
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once the fund is created it's share pool is fixed
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and if someone wants to buy or sell a share
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it happens in the secondary market
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so they're buying and selling from each other
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they're not dealing with the actual fund manager
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The disadvantage from the fund manager here
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is it's much less flexible
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in terms of growing or shrinking the fund
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The advantage is this fund manager
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doesn't have to keep cash around
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in case the share holders want to redeem
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In the open-ended fund we saw that the manager
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has to keep some cash around in case one of these
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investors wants their money back
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here - the closed-end fund - he knows that no one
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can get their money back right here
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so he or she can invest as they see fit
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