What is Dual-Purpose Fund?
A closed-end fund that holds both common shares and preferred stocks. shares is a dual-purpose fund. A closed-end fund is a category of a mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments
With Dual-Purpose funds, Investors can choose to buy preferred shares or invest in common shares to profit from potential capital gains, the income derived from the dividends and interests of preferred shares. Although preferred shares allow investors to derive a steady income stream, they are not subject to any appreciation in the capital. Common shares on the contrary offer potentially great gains, even though the profit margins are not that reliable.
On the establishment of a dual-purpose fund, the liquidation date is set for shares to be redeemed at a specific price. On the given day, preferred shareholders are prioritized for payout, that they are eligible up to the par value or the face value of their shares. The remaining capital left over from the fund is open for distribution to common shareholders.
Dual-purpose funds offer investors more than one opportunity to make money within the same investment. They can choose the more suited share class, aligned to their investment objectives and respective risk appetite. Investors with a lower tolerance for risk are more inclined towards preferred shares or income shares, whilst investors keen on common shares or capital shares tend to have a higher risk appetite.
In scenarios of increased portfolio value of a dual-purpose fund, the capital shareholders tend to draw good value in their profits. Likewise, in events of a drop in the portfolio value, capital shares stand to lose money, marking a loss for the common shareholders.
How a Closed-End Fund Works
A close-ended fund is structured and publicly traded over the exchange. However, it differs from other regular shares of stock, in its representation of the interest in the portfolio of investments actively managed by an investment advisor.
Similar to ETFs, closed-end funds have ticker symbols and trade on the public exchange throughout the day. In the majority of aspects, closed-end funds are similar to mutual funds, from the perspective of an investor. They are designed to exploit opportunities across specific industry sectors, regions, and markets and can be characterized by their investment style and the degree of risk tolerance on the scale of aggressive to conservative. The funds are also charged an annual expense ratio and contribute to the income and capital gain distribution for their investors.
Open-End vs. Closed-End Mutual Funds
A diversified portfolio or pooled investor money, with an unlimited number of shares for an issue, is referred to as an open-end fund. In the case of an open-end fund, fund sponsors sell shares directly to investors and can also redeem them. Open-end fund shares are priced daily basis as per their NAV- net asset value. Common instances include mutual funds, hedge funds, and exchange-traded funds. Unlike the more common, open-end funds, which price only once at the end of the day, close-end funds trade throughout the day. Additionally, closed-end funds require a brokerage account for the trading of shares, which also is contrary to open-end funds.
The stock prices of all closed-end funds fluctuate basis on their supply and demand, as well as the fluctuating values of the fund holdings. The net asset value of the funds is regularly published on the stock exchanges. However, closed-end funds often trade at a discount to NAV or a premium. The discount or the premium is often determined based on the reputation of the fund manager as a stockpicker or the popularity of the underlying holdings.
A disadvantage of all closed-end is due to their illiquidity, which implies their unavailability of insufficient volume, for sellers to exit their investments quickly without the downside of a substantial loss.
Dual-Purpose Funds and Treasury STRIPS
The common shares of dual-purpose funds have a parallel counterpart in the fixed-income investments in the form of Treasury STRIPS - Separate Trading of Registered Interest and Principal of Securities, which is often referred to as zero-coupon bonds as they pay no interest or coupon.
Treasury STRIPS are United States bonds sold at a discount to their face value. While the investors do not stand to receive any interest payments, they tend to be repaid the full face value when the bonds mature, ”at par”.
The STRIPS coupons are sold as separate investments from the bond or note. The return booked by an investor depends on the difference between the purchase price and the bond’s trading value or the face value if held till maturity. Common shares of the dual-purpose fund are similarly stripped out of the income portion of the return.