We propose a solution to the closed-end fund puzzle in financial markets without a free lunch with vanishing risk. Our results are consistent with both the time-series and the cross-sectional aspect of the closed-end fund puzzle. It turns out that a closed-end fund cannot exist if the fund manager is supposed to receive a fee although he is not able to find mispriced assets in the market. By contrast, a premium can typically be observed at the initial public offering because the fund manager has access to information that enables him to create a dominant strategy. As soon as this weak arbitrage opportunity evaporates, a premium can no longer occur. The reason why a premium quickly turns into a discount might be that the fund manager stops applying a superior trading strategy at some point in time. Another possibility is that abnormal profits are transient in a competitive financial market. In any case, when the fund manager is no longer willing or able to maintain a superior strategy, the fund must trade at a discount in order to compensate for his management fee.
