Closed-end funds are not nearly as well-known as open-end mutual funds, which dominate the market with trillions in assets.

But the $300 billion-plus sector does offer potential and somewhat unique advantages for investors, experts noted in a recent panel discussion on closed-end funds hosted by TheStreet.

(Click here to register and watch the discussion for free.) 

Closed-end funds enjoy three key advantages over mutual funds and ETFs, according to panel members.

1. Closed-end funds are structured differently than their open-end cousins, with potentially more capital stability that can benefit more risk-inclined fund managers.

2. Closed-end managers can use leverage to double down on winning positions, accelerating gains.

3. Because of the quirky pricing structure of closed-end funds, investors can often buy the assets in a closed-end fund at a significant discount.

All three advantages can also have downsides, especially the ability to take on debt, which can backfire in a down market.

If nothing else, closed-end funds are complex, and require investors ready to embrace that complexity and get to know their quirks.

"You do really have a ton of opportunity," said Daniel Wolfe, president of 180 Degree Capital, a publicly-traded investment company. "The issue is you just have to spend time to really understand what each one (fund) is. It's not just 'do a quick screen and get out the fund.'"

Different capital structure

Closed-end funds raise money to buy assets through the IPO process. A fixed number of shares are sold and then the fund is traded on various exchanges throughout the day.

Unlike standard open-end mutual funds which can expand or contract the number of shares based on market demand, the only way to sell shares in a closed-end fund is to find a buyer willing to take them.

This can provide a fund manager interested in delving into riskier but potentially more lucrative niches, whether it's an emerging market or a real estate deal, with a more solid base of capital with which to work.

If investors in an open-end mutual fund or ETF get word of an investment risky strategy, they can cause a run on the fund by racing to sell, with the fund having no choice but to redeem their shares.

"Because closed-end funds don't make liquidity for investors on a daily basis, they're able to stay fully invested and maybe invest in certain asset classes that might be a little less liquid, maybe a little more interesting than what open end funds might be able, " noted Bill Meyers, a vice president at Nuveen, which offers several closed-end funds.

(Full disclosure: Nuveen is an advertiser on TheStreet, but did not participate in the preparation of this article.)

The downside: In a downturn, investors may want to flee from anything perceived as a risky bet. While a closed-end fund won't have to fear losing capital, investors who bought shares may have trouble finding buyers if they want to get out.

Fund managers armed with credit

Closed-end funds are typically the antithesis of ETFs, designed for passive investment strategies that offer a low cost way to mirror the market.

By contrast, managers of closed-end funds are typically paid relatively high fees in order to chase the best results.

And one very potent weapon that closed-end fund managers have in their arsenal is the ability to borrow.

Closed-end fund managers can use leverage to buy more assets and double down on their various positions.

They can do this in two ways, by either issuing preferred shares or inking a loan agreement with a bank or other financial institution.

In a rising market, leverage can amplify gains on the way up. But in a down market, debt taken on to buy additional stocks, bonds or other investments can backfire, accelerating losses.

"It cuts both ways," Nuveen's Meyers said. "It can help you or it can hurt you in adverse markets."

Buying assets at a discount

The capital structure of closed-end funds -- and the way they are traded on the market -- also creates opportunities for investors to bargain hunt.

Closed-end funds raise money to buy assets through the IPO process. A fixed number of shares are sold and then the fund is traded on various exchanges throughout the day.

The fixed-number of shares can lead to greater variability and even volatility in the price of closed-end funds, with gaps often opening up between the trading price and the value of the underlying portfolio of assets.

This often results in a discount situation, in which the investor can snap up a dollar's worth of stocks and bonds, say, for 90 cents.

The large majority of closed end funds - roughly 80 percent - are priced at a discount to their net asset value.

Investors buy closed-end funds at a discount in hopes is that the gap between the share price and the net asset value of the portfolio will narrow, generating a nice profit. If it widens, the bet goes in the opposite direction.

"When advisors or investors in general are thinking about closed-end funds, the idea that you can pay $9 per share fund price, but buy, say, $10 per share of assets, it's trading at a 10% discount, for example, that's one of the most attractive things that people historically have looked at closed-end funds for," said Daniel Silver, a CFA and a vice president and relationship manager at CIBC Private Wealth Management.

Want to Buy $1 Worth of Stock for 90 Cents or Less? You can with certain so-called "closed-end" mutual funds -- an often overlooked investment class. Click here to register for a free online video in which TheStreet's retirement expert Robert Powell and an all-star panel tell you all you need to know.

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