It's essential to understand the ins-and-outs of buying and selling closed-end fund shares to have the best possible investment results with your CEFs. The cost of trading any stock includes three components:

1) Brokerage commissions: Buying and selling your CEFs through an online brokerage can minimize commissions.

2) Bid-asked spread: The quote on every stock includes both a "bid" and an "asked" price. Fund A might be quoted at 10 bid, 10-1/8 asked. The bid is the highest price someone is willing to pay to buy the CEF, and the asked is the lowest price at which someone is willing to sell it. The spread becomes a part of the transaction costs when investors buy at the asked or sell at the bid. Thus, if an investor buys 1,200 shares of a CEF with a 1/8th point spread, the price differential effectively costs $150 (1,200 shares divided by 8). The spread often is a bigger cost than the commissions.

3) Market impact costs: A relatively big order exerts pressure on price. Market impact costs become a problem if an investor places an order to buy or sell a quantity of shares that is large relative to a CEF's average daily share volume. Assume an individual wants to buy 10,000 shares of a fund with a 5,000-share daily volume. This order could bump the asked price up by 1/8th point or so, driving up trading costs.

Gauging Liquidity

Market impact costs are less significant with liquid funds. Liquidity refers to the ease with which an investment can be bought or sold without disturbing its price. The more shares you can buy or sell at the current quote, the higher the liquidity. Of course, what's liquid to a person wishing to trade 100 shares could be highly illiquid to another with a 10,000-share order.

Two important indicators of CEF liquidity are:

1) Average daily share volume: The higher the daily volume the more liquid the fund. A fund that trades 200,000 shares on average is more liquid than one that trades 20,000 shares.

2) The "size" in the quote: The size reflects demand and supply. A quote of "8-5/16 to 8-3/8, 55 by 21" means that 5,500 shares are bid for at 8-5/16 and 2,100 are offered at 8-3/8. (You need to add two zeros to each "size" number). Bigger numbers indicate greater liquidity. Size changes throughout the day so savvy investors track it closely when attempting to buy or sell shares. The size is available online if you have access to real time quotes, or through your broker.

If you decide to buy or sell a large block of a thinly traded fund you may want to break your order up into several smaller ones and feed them in gradually to avoid putting excessive pressure on price, thereby minimizing market impact costs.

Locking In Your Price With Limit Orders

The careful placement of limit orders can be a great way to minimize trading costs. Limit orders are instructions to buy or sell at a specific price or better. For example, an order might be "buy 1,000 shares of Fund A at 9-15/16," when the fund is quoted at 10 bid, 10-1/8 asked. By using limit orders and being patient you'll often receive a better price than buying or selling at the market. Closed-end share prices fluctuate more than their NAVs. A fund's price might bob up and down a quarter or even a half point during a day. Thus, it often pays to place limit orders to buy at the bid or sell at the asked (or perhaps between the two). Some people will go in a bit below the bid or above the asked. It depends on how much of a hurry you are to buy or sell. Of course, there's always the risk that you could miss an opportunity by being too picky about price.

A limit order can be entered either as a "day" or "good till canceled" (GTC) order. The former expires at the end of the day if it is not executed. GTC orders remain in effect until they either are filled or canceled. The brokerage firm may place a time limit such as 60 days on the duration of all limit orders.

Each CEF has its own "trading personality" so it can pay to keep an eye on a fund's bid, asked, size and volume for several days before placing an order. In addition, keep up to date on a fund's discount (or premium) by checking the Closed-End Fund Association's Web site for daily changes. You also need to think about discounts and premiums when placing limit orders.

Other Considerations

Future articles will explore other transaction topics of interest to CEF investors, including the following:

• Buying shares around the ex-dividend date requires special considerations when placing limit orders because the stock price normally declines when a fund goes "ex." However, the price might not fall by the full amount of the dividend.
  
  
• Certain CEFs offer cash purchase plans allowing shareholders to buy more shares directly from the fund. The plan usually is offered by the fund's transfer agent in conjunction with a dividend reinvestment plan. This topic will be addressed in an article explaining how dividend reinvestment and cash payment plans work.
  
  
  

  __________________________________________________________________________ * Albert J. Fredman is a professor of finance at California State University, Fullerton. He has co-authored Investing in Closed-End Funds (New York Institute of Finance/Prentice Hall, 1991) with George Cole Scott. His most recent book is How Mutual Funds Work Second Edition (New York Institute of Finance/Prentice Hall, 1998, with Russ Wiles). He has written the quarterly mutual fund column for the AAII Journal since 1993. Fredman's article "Leveraged Closed-End Equity Funds: Evaluating the Risks and Rewards" (co-authored with Eugene L. DeStaebler, Jr. of General American Investors Company, Inc.) is forthcoming in the Spring 2000 issue of The Journal of Investing. If you would like more information on Closed-End Fund companies link to our Closed-End Funds. __________________________________________________________________________