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Closed End Funds: Respect the Vehicle

|Includes:BHD, EOS, Franklin Universal Trust (FT), GDO


I feel prompted to write this article for the inexperienced CEF investor due to the general lack of understanding and hasty judgment that these investors voice on my articles (as well as on the articles of my peers).  How many times have we all seen the same "Return of Capital", "Upper-left to Bottom-right", "Leverage", etc comment and rolled our eyes?  As a newer contributor on this site I have incurred substantially fewer instances of this plague than many of my peers, but with the wealth of quality CEF information to be found I continually find myself amazed at the ignorance.  I find myself to be a man in a library, surrounded my classic literature and persons that do not know how to read.  To harsh?  I think not.  If you happen to be one of the illiterate, take heart.  I am not purely dispensing judgment, but I am here as an aid to your search for knowledge.  I do not want to be your Virgil, holding your hand every step of the way, but I will at least try to point you in the right direction.  With that being the case, here goes the finger-pointing:

1.) CEFs are NOT mutual funds.
-CEFs are closed-ended funds while mutual funds are open-ended funds.  CEFs trade intraday based upon supply and demand, mutual fund trades settle up at market close.

2.) Many CEFs are income investments.
-Income is the primary portfolio objective on many CEFs, especially the funds mentioned on this site.  Capital preservation and appreciation are NOT usually the primary objective.  Since this is the case, why would you be surprised if a CEF manager manages to meet a dividend instead of managing to growth.  Read the portfolio objective and buy accordingly.

3.) Leverage is not a bad thing, it is an OPTION.
-Please, please, please quit beating up on leveraged CEFs.  Leverage is not evil.  You leverage yourself every day.  You leverage your time, your money, your relationships, etc.  Leverage is a mechanism that provides you with a desired result given the appropriate market.  Sometime leverage is appropriate, other times it is not, but every investor is unique and every investor should have the OPTION to employ leverage in their investments if they choose to do so.

4.) CEFs only lose money.
-I hate to dignify this question, but let me answer this briefly.  CEFs are one of the few remaining investment sectors where the institutional and the retail investor can effectively exploit market inefficiencies.  The premium/discount opportunities are extremely attractive and available to everyone.  With that being said, yes, some CEFs have a downward trend, but ask yourself why, and then go to point number 2 and you should have your answer.  On top of this fact, many dividend/income CEFs are mandated to be very nearly fully invested at all times in order to maximize the income, and this can lead to the NAV participating more fully in market downturns and less so on market upturns.

I hope these 4 points aided in your overall understanding of CEFs.  CEFs are unique vehicles, and if you employ adequate and appropriate level of understanding and respect you should be able to add these funds into your investment tool-box.  With that being said, let me mention a few CEFs that are particularly attractive from a +/-, earnings, UNII, and current income perspective: BHD, GDO, EOS, and FT.  Enjoy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: FT, EOS, GDO, BHD