Organizational form and liquidity management: Evidence from open- vs. closed-end municipal bond funds

This paper studies how the organizational forms of open- and closed-end funds affect their ability to manage illiquid assets. We use a sample of municipal bond funds from 2002 to 2015 to compare the portfolio liquidity and performance of open- and closed-end funds. We find that immunity to redemption risk allows closed-end funds to hold more illiquid municipal bonds than open-end funds, and they charge higher management fees for such liquidity provision. Closed-end funds earn liquidity premiums from their illiquid holdings. They significantly underperform peer open-end funds after controlling for their exposure to liquidity risk. Highly leveraged closed-end funds are subject to systematic liquidity risk. We find that closed-end funds with higher leverage hold more liquid municipal bonds. They trade more liquid municipal bonds to reduce the potential costs at forced deleverage. •Open-end funds face flow-based idiosyncratic liquidity shocks.•Levered closed-end funds face systematic liquidity shocks.•Immunity to redemption risk allows CEFs to hold more illiquid securities than OEFs.•CEFs with more illiquid holdings charge higher management fees.•CEFs with higher leverage hold more liquid municipal bonds.•Portfolio liquidity can significantly explain fund performance;