That’s the promise of closed-end funds.
Although they’ve been around since 1893, they’re not nearly as popular as mutual funds and exchange-traded funds (ETFs).
That’s because closed-end fund managers don’t spend millions of their customers’ dollars advertising in financial magazines. Wall Street firms do not follow them.
That’s how sophisticated investors keep the good news about closed-end funds to themselves. They nail down a quarterly or monthly income – that you buy on sale.
As of the end of 2017, there were 530 closed-end funds.
So far in 2019, six new closed-end funds have come out:
* Blackrock Science and Technology (BSTZ)
* Nuveen Municipal Credit Opportunities (NMCO)
* PIMCO Energy & Tactical Credit Opps (NRGX)
* RiverNorth Managed Duration Municipal Income Fund, Inc. (RMM)
* Tortoise Essential Assets Income Term Fund (TEAF)
* Angel Oak Financial Strategies Income Term Trust (FINS)
These 2019 funds offer a diverse array of investing opportunities, from municipal funds to high tech to debt issued by community banks.
Community bank debt is not a sector most people would or could consider.
That’s part of the appeal of many closed-end funds. You get the benefit of management’s insider expertise in little-known sectors of the markets.
Obviously, you don’t want to bet the farm on such a sector, but it’s an easy way to diversify your portfolio away from the usual stocks.
What are Closed-End Funds?
The fund management company buys a group of investments. These are typically bonds and high-yield equities such as master limited partnerships and real estate investment trusts.
Bonds are most popular, with around 60% of all CEFs holding them. However, there’re a wide variety of assets held by CEFs.
These investments pay interest or dividends. This income is sent out to owners of the fund’s shares, just like stock dividends – and on a quarterly or monthly basis.
The management company issues a fixed number of fund shares, selling them on the open market through an Initial Public Offering (IPO).
From that point on, the shares sell on the stock exchanges, just like stock.
CEF managers do actively manage the underlying assets the fund holds. That’s similar to actively managed, open-ended mutual funds, but different from most ETFs, which usually replicate an index.
The Fund Share Price Go Up or Down With the Market
That’s basically like an exchange-traded fund.
However, unlike ETFs, a CEF’s stock price does not precisely reflect the total market value of the fund’s holdings.
Usually, CEFs sell for either more or less than their Net Asset Value (NAV).
That’s the part about CEFs that is counterintuitive. ETFs have a formal process that keeps their share prices in line with the market value of their underlying assets.
CEFs don’t. Therefore, before you ever buy a CEF, you should check on whether its NAV is more or less than the market price.
If the NAV is lower than the market price, it’s trading at a premium. Don’t buy it.
Much of the time, however, CEFs trade at a discount to their NAVs, which is great.
For example: a CEF is trading at a 10% discount to NAV. That means it’s worth $10, but you can buy it for $9.
What are the Risks of Closed-End Funds?
As with any kind of fund, there’s the business risk faced by the underlying investments.
There’s also the risk the market prices of those investments could go down. If you bought them for a discounted price, however, you won’t lose as much money as other investors. In the meantime, enjoy the stream of income you bought on sale.
Some closed-end funds use leverage to enhance returns. In bad times, this can increase losses. About 64% of CEFs are using leverage.
Unlike regular, open-ended mutual funds, you cannot cash in the shares you own. You can, however, always sell them just like shares of stock. But older funds may not be highly liquid.
The NAV can go up or down, depending on investor sentiment and market conditions. It’s good to buy income investments on sale for 10% off, but next year the NAV might be selling for a 15% discount.
Therefore, to invest safely in closed-end funds:
* Diversify. Don’t just own lots of CEFs, but CEFs holding many types of bonds and equities.
* Don’t sell. That way, you avoid paying capital gains taxes, and you won’t lose money by realizing capital losses. You buy CEFs to receive streams of income, not for price appreciation. Just keep cashing the checks.
