Traditional closed-end funds invest in assets such as real estate, ships or aircraft, with the investment amount for the purchase of the asset and all other costs and expenses being fixed from the onset. The total investment volume is usually made up of debt capital provided by banks and equity capital invested in the form of a participatory interest of an entrepreneurial nature. Once the fund reaches its predetermined equity capital level, the fund is closed. By investing in the fund, the investor becomes a partner or shareholder in the fund company and thus co-owner. As a result, the investor partakes in the financial results derived from the rental income of real estate or the charter/leasing income from ships or aircraft.
In the ordinary course of an investment, investors will receive an annual pro rata distribution from the operating results of the fund company. These are earnings from co-ownership in the fund company, which – in the case of shipping funds – are distributed almost free of tax as a result of the flat-rate tonnage tax. In the case of real estate located in countries with which Germany has entered into a double taxation treaty, any such distributions are only subject to the proviso of applying progressive tax rates (Progressionsvorbehalt). The annual distributions are made until the asset (real estate, ship or aircraft) is sold. The investor also receives a pro-rated share in the sales proceeds. Once all of the fund company's proceeds have been distributed and its liabilities have been paid, the fund company is liquidated.
Opportunities and risks
Closed-end funds investing in dynamic markets, such as the shipping industry, can inject fresh momentum into investment portfolios by generating attractive returns. Security-oriented closed-end funds can also be used to further stabilise a portfolio, as they offer good returns despite their strong security bias, thereby compensating for portfolio assets that are less profitable. What's more, closed-end funds usually do not correlate with other asset classes.
When deciding in favour of investing in a closed-end fund, investors should be aware that they are acquiring a participatory interest that constitutes co-ownership in a company. An investment of this nature provides good opportunities for comparatively high returns but also entails the risk that the investment does not take the expected course, generating a lower return than planned. In the worst case scenario, the investor may lose their contributed capital.
For these reasons, investors should opt for closed-end funds incepted by underwriting houses having many years of experience and an excellent track record. Conscientious underwriting houses document their results in the form of performance records, showing the results generated by each individual fund (please also refer to the performance records in the Companies section).
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