by Fred Fuld III
Closed-end funds (CEFs) are investment vehicles that pool money from multiple investors to invest in various assets such as stocks, bonds, or other securities. Unlike mutual funds or exchange-traded funds (ETFs), CEFs have a fixed number of shares, which are traded on stock exchanges like individual stocks.
How CEFs Work
Here’s how closed-end funds work:
Initial Public Offering (IPO): When a closed-end fund is launched, it goes through an IPO where a fixed number of shares are issued and sold to investors.
Active Management: CEFs are typically actively managed by professional fund managers who make investment decisions on behalf of the fund. Their goal is to generate returns by investing in a diversified portfolio of assets.
Stock Exchange Trading: Once the IPO is complete, the shares of the CEF are listed on a stock exchange, allowing investors to buy or sell shares throughout the trading day. The price of CEF shares is determined by supply and demand dynamics in the market and may deviate from the fund’s net asset value (NAV).
Leverage: Some closed-end funds may use leverage by borrowing money to make additional investments. This can potentially enhance returns but also increases risk.
Advantages of CEFs
Now, let’s discuss why it may be advantageous to invest in CEFs selling at a discount:
Buying Below Net Asset Value (NAV): CEFs often trade at a price that is lower than their NAV per share. This discount can occur due to market sentiment, investor behavior, or perceived concerns about the fund. Investing in CEFs at a discount means you can acquire a dollar’s worth of assets for less than a dollar.
Potential for Capital Appreciation: If a CEF’s share price eventually converges with its NAV, investors who purchased shares at a discount can benefit from capital appreciation. As the discount narrows or disappears, the value of their investment increases.
Higher Income Yield: CEFs typically distribute income generated from their underlying assets to shareholders. Buying CEFs at a discount can result in a higher income yield since the distribution is calculated based on the NAV, while the purchase price is lower.
Diversification and Professional Management: CEFs offer diversification benefits by investing in a portfolio of different securities. Moreover, they are managed by professional fund managers who employ their expertise to select investments, potentially generating attractive returns.
Potential for Active Trading Strategies: The market price of CEF shares can deviate significantly from the underlying NAV, providing opportunities for active traders to capitalize on these price discrepancies through short-term trading strategies.
It’s important to note that investing in CEFs involves risks, such as market volatility, interest rate fluctuations, and the performance of the underlying assets. Additionally, the discount at which a CEF trades may persist or widen, resulting in potential losses for investors. Therefore, thorough research and consideration of individual CEFs and their investment strategies is crucial before making investment decisions.
Closed End Bond Funds
Closed-end bond funds are a type of closed-end fund that specifically invests in a portfolio of bonds or other fixed-income securities. These funds pool money from multiple investors to invest in a diversified range of bonds, including government bonds, corporate bonds, municipal bonds, or even international bonds.
Here are some key characteristics of closed-end bond funds:
Income Generation: The primary objective of closed-end bond funds is to generate income for investors. They typically invest in fixed-income securities that pay regular interest or coupon payments. The income earned from these bonds is then distributed to shareholders in the form of regular dividends.
Interest Rate Sensitivity: Closed-end bond funds are sensitive to changes in interest rates. When interest rates rise, bond prices tend to fall, which can negatively impact the net asset value (NAV) of the fund. On the other hand, when interest rates decline, bond prices tend to rise, potentially leading to an increase in the NAV.
Portfolio Diversification: Closed-end bond funds provide investors with a diversified portfolio of bonds. By investing in a variety of issuers, sectors, and maturities, these funds aim to mitigate risk and reduce the impact of any individual bond’s performance on the overall fund.
Credit Quality: Closed-end bond funds may invest in bonds with different credit ratings, ranging from high-quality investment-grade bonds to lower-rated or even non-investment-grade bonds (also known as junk bonds). The credit quality of the bonds held by the fund affects the overall risk profile and potential return of the fund.
Leverage: Some closed-end bond funds may use leverage to enhance returns. They borrow money to invest in additional bonds, aiming to generate a higher income for shareholders. However, leverage also amplifies risk, as it can magnify losses if the market moves against the fund’s positions.
Discount or Premium: Like other closed-end funds, closed-end bond funds can trade at a price that is either below (discount) or above (premium) their NAV per share. The discount or premium reflects market sentiment, supply and demand dynamics, and investor perception of the fund’s performance and prospects.
High Yield, Payable Monthly, Selling at a Discount to NAV
Here are some examples of bond CEFs that have a high yield in excess of 10%, pay dividends monthly, and are selling at a discount to Net Asset Value.
| Company | Symbol | Yield | Periodic | Discount to NAV |
| Highland Funds I – Highland Income Fund | HFRO | 10.36% | Monthly | -33.23% |
| FS Credit Opportunities Corp. | FSCO | 13.55% | Monthly | -32.20% |
| High Income Securities Fund | PCF | 11.84% | Monthly | -16.69% |
| Legg Mason BW Global Income Opp Fund | BWG | 12.80% | Monthly | -15.92% |
| Virtus Convertible & Income Fund II | NCZ | 12.90% | Monthly | -15.71% |
| Virtus Convertible & Income Fund | NCV | 12.99% | Monthly | -15.59% |
| Western Asset Mortgage Opportunity Fund | DMO | 11.70% | Monthly | -15.07% |
Investing in closed-end bond funds offers potential advantages such as regular income, diversification, and professional management. However, it’s crucial to carefully evaluate the specific fund’s investment strategy, credit quality, interest rate risk, leverage, and expense ratios. Additionally, investors should be mindful of the potential impact of changes in interest rates and market conditions on the performance of these funds.
Disclosure: Author didn’t own any of the above at the time the article was written.