Closed-End Funds are innovative and flexible investment products designed to respond to modern investor needs, be it for yield enhancement, capital protection or risk reduction. Over the past decade, they have become part of the financial mainstream.
Closed-End Funds as at August 31, 2016:
Generally, these products use funds raised through a public offering to invest in a portfolio of securities which may be actively or passively managed. The objective of most funds is to create an income stream for investors from dividends, capital gains, interest payments or capital appreciations from underlying investments. These funds employ various investment management tools from leverage to derivative investment strategies to enhance the returns of the fund or for capital protection. These funds are not related to or hold a significant position in any single business.
Investment Funds, similar to mutual funds, are innovative and flexible investment products designed to respond to modern investor needs, be it for yield enhancement, capital protection or risk reduction. These products offer a variety of investment products that focus on investing in different sectors or assets classes such as energy, real estate, large cap or small cap equities, indices, debt securities, mortgages and senior loans. They also use different investment strategies such as leverage or derivatives with the goal of enhancing the portfolio returns or for capital protection. Generally, these products use funds raised through a public offering to invest in a portfolio of securities which are actively managed to create income streams for investors through a combination of dividends, capital gains, and interest payments. Most often, these funds are not related to operating businesses.
The "split share" structure is another unique type of financial Closed-End Fund. The split share structure allows the risk-reward component of common shares to be broken down into two components and then allocated differently for investors who are more or less risk averse.
A split share corporation will hold common shares of one company or more, typically a portfolio of common shares (based on a sector or industry). The corporation then issues two classes of shares - capital shares and preferred shares. For preferred shareholders, the objective is to generate fixed cumulative preferential dividends and to return the original investment. For capital shareholders, the objective is to increase investors' participation in any capital appreciation (or depreciation) in the underlying portfolio shares and to benefit from any increase in the dividends paid on the portfolio shares. With the use of leverage, the capital shareholders can realize a greater proportionate change in the value of the capital shares vs. the underlying common share (e.g. $1 increase in the common share price translates into a $1.50 increase in the capital shares).
Using this structure, a portfolio of regular common shares can be divided into capital shares that have a higher level of risk than the underlying common shares and preferred shares that exhibit lower risk than the underlying common shares. Therefore, the distinction between the class of shares issued by a split share corporation is very important.
Capital trusts are more like a fixed income instrument than an equity issue. They are generally issued by banks or other financial intermediaries. The business objective of capital trusts is to acquire and hold assets that will generate net income for distribution to unitholders. The trust's assets may consist of residential mortgages, mortgage co-ownership interests, mortgage-backed securities, other eligible investments and other qualified debt obligations. Capital trust assets are usually acquired from and serviced by the issuing institution and/or its affiliates.
Principal protected notes (PPNs) offer investors a guarantee on the return of their principal investment, if held to maturity, protection against foreign currency fluctuations, plus any potential investment gains. Investors can earn a return on their investment because PPNs provide investors exposure to or combination of the returns of indices, foreign or domestic stocks, commodities, mutual fund portfolios, fixed income securities or inflation.
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Dani Lipkin, Head, Business Development, ETFs and Closed-End Funds