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How to fall in love with your fund

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About Cecilia L. Gondor

Cecilia Gondor is executive vice president and chief investment officer of Thomas J. Herzfeld Advisors, Inc., an investment management firm specializing in closed-end fund research, analysis, and investment since 1984.

Gondor also is the secretary, treasurer and chief compliance officer of The Herzfeld Caribbean Basin Fund, Inc., the first closed-end fund formed to invest in the Caribbean region (NASDAQ: CUBA). Since 2012, she has served as co-portfolio manager of the Virtus Herzfeld Fund, an open-end mutual fund subadvised by Herzfeld Advisors for Virtus Investment Partners.

In addition, Gondor is head of research at Herzfeld Advisors and the editor of the firm’s monthly research publication, The Investor’s Guide to Closed-End Funds, a comprehensive report which deals with timely topics related to the closed-end fund industry. She began her career in the investment industry in 1984.

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By Cecilia L. Gondor

When it comes to choosing open-end mutual funds vs. closed-end funds, investors seek distinctly different qualities from each type of investment. Although there are considerably more open-end mutual funds on the market, closed-end funds span a vast array of investment objectives, albeit with a bias toward income-generating strategies.

In screening prospective funds, whether closed- or open-end, beauty truly is in the eye of the beholder. Certain attributes that rank highly for mutual-fund investors are at the bottom of the list for closed-end aficionados and vice versa. Adding to the attraction, each fund structure offers special attributes the other does not.

In the spirit of this month's Valentine's theme and finding one's "match," let's take a closer look at the selection process for open- and closed-end funds to see what appeals most to investors, ranked in order of importance.

Open-end mutual funds

1. Performance

Open-end-fund investors generally gravitate to funds that have displayed superior performance, both long and short term, often selecting sectors that are currently in vogue.

2. Third-party-fund ratings

Various rating services rank funds — such as Morningstar's widely recognized and respected five-star system — based largely on past performance and risk metrics.

3. Expense ratio

Open-end-fund investors are highly sensitive to the impact of a fund's operating expenses on their returns, and understandably favor funds with lower expense ratios.

4. Volatility

The volatility of open-end funds is measured by net asset value (NAV) volatility using the key metrics of standard deviation and, in the case of interest-rate-sensitive funds, portfolio duration. A higher standard deviation suggests greater risk, so investors tend to prefer lower measures. Nevertheless, higher deviations may be acceptable and even desirable to investors who can tolerate it. Duration measures how strongly a fund's NAV will react to a change in interest rates; the higher the number, the greater the reaction.

5. Yield or distribution rate

For funds with an income component, open-end-fund investors place an emphasis on how much the fund distributes and how often payouts are made. Distribution size expectations are typically more moderate than for closed-end funds. Unlike for closed-end funds, many open-end-fund investors opt for reinvestment.

6. Turnover ratio

This refers to how actively the portfolio is traded and is directly proportional to underlying transaction costs, which are embedded in the expense ratio. Turnover ratio is a prominently presented statistic for open-end funds. In investors' eyes, low turnover is preferable to high turnover.

7. Investment manager

Name recognition is particularly important among open-end fund investors. Some are loyal to one asset management group, selecting several different funds under the same advisor's umbrella.

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