At the urging of one of the largest money managers in the world, they are a client of mine, I am returning to the subject of closed-end funds. In my friend's opinion, in my opinion, there is no sector of the markets that is more overlooked, less understood, and more full of promise, than closed-end funds.
Closed-ends funds should not be purchased for appreciation, though you may get some. They should be utilized for yield and cash flows. Many of these funds pay monthly, or quarterly, and so it is possible to attain a steady stream of income in this space. You can also find yields with two numbers attached to their returns, which is almost impossible to find in any other space.
The main reasons, in my view, that closed-end funds are so overlooked is that they more money that flows into them does not increase the money that the sponsor of the fund, the manager of the fund, make, and so there is to tout, virtually no advertising, or no discussion of them in our business publications. The one exception to this has been Randall Forsyth, the renowned author of "Up and Down Wall Street" in Barron's. He has focused on them several times and his musings are worth the read. He, in my estimation, is one of the most astute people on Wall Street and he appreciates the potential value of these funds.
You know, whether a person or an institution, the primary strategy for investing is appreciation. Buy a stock at 5 and hopes it goes to 10 or, conversely, sell a stock at 10 and hope it declines to 5. This is the bulk of what everyone is trying to accomplish. However, in tandem, and not as a replacement, is the strategy to gain yield and cash flows to support your business or your lifestyle.
For generation this was the primary space for bonds, and other instruments, such as mortgage securities, founded upon steady returns. However, with yields where they are now for Treasuries and virtually all credit securities, these instruments are just not getting the job done for almost anyone.
The primary alternatives that have been suggested are single stocks with dividends, Exchange Traded Funds (ETFs), and REITs. There is nothing wrong with these alternatives but, in my considered opinion, you can find much better alternatives in closed-end funds. They are complicated, you have to know what you are doing, and a broad number of factors have to be considered when choosing them. There are approximately 650 closed-end funds and, I will tell you, I only suggest about 30-35 of them to clients.
One of the major criticisms of these funds, over the years, has been that they use leverage. It is regulated to a maximum of 50%, by statute, but most of them are in the 20%-30% area. This was a valid concern, in times past, but when interest rates are just off of Zero then the cost of the leverage, for many funds, is also just this side Zero and so a very effective tool for increasing yield, regardless of the sector of the fund.
There are closed-end funds concentrated in a wide variety of areas. There are investment grade bond funds, high yield bond funds, convertible bond funds, and loan funds and that is just the fixed income part of the choices. There are also real estate ones, equity funds, MLP funds, which I have recently been avoiding, and even some floating rate funds that also hedge against Inflation. I also, this morning, want to warn on one other criteria which is liquidity. I would pay special attention to the average number of shares traded daily and avoid those funds where liquidity is an issue.
Also pay close attention to the Net Asset Value (NAV) and the 1-5 year history of the NAV and also to the history of any fund's dividend payments. For many people, these funds are just to complicated to assess correctly and I advise most individuals to get some help here from a professional. You can stumble around in this space, and bang up your knees, if you do not know what you are doing.
Another major factor here is the manager of the fund. What is their track record? What is their level of experience? What is the quality of the person, or persons, who are running the fund and how much history do they have in fund management? Closed-end funds also pay dividends, like many stocks, and I also note that they can be raised, can be cut, or pay a special dividend all at the discretion of their Board, just like any other stock.
Finally, I wish to take a moment to thank the financial press, and many research analysts, for overlooking this segment of the market. If you had paid attention to closed-end funds, and their outsized yields, then their current returns would not be available. I am delighted you ignored them, as I reaped the benefits. Your ignorance has been my bliss.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
This article was written by