Understanding Closed End Funds (CEF) – Great for High Yields in a Flat Market

GrowthInvestors looking for higher yields in this stagnate market may want to understand how closed end funds work and how they differ from Mutual Funds and ETF’s. See my current CEF holdings at the end of this article.

Summary:

  1. Closed end funds are quite different than Mutual Funds (open end funds). A CEF raises a fixed amount of money and issues a fixed number of shares. A Mutual Fund continues to raise money and adds shares as people invest.
  2. CEF’s typically are used by institutions and private investors as a way to generate steady income.
  3. CEF’s typically trade at a discount to their Net Asset Value, NAV. This offers investors enhanced potential gains. Mutual Funds are revalued each evening to their NAV.
  4. All CEF’s are actively managed, most Mutual Funds are tied to an index and are much more passive.
  5. A CEF trades just like a regular stock, bid/ask pricing, this means that market demand determines the price. A Mutual Fund determine an actual price at 4 PM each day as the market closes. CEF’s tend to be much more transparent.
  6. A CEF’s actual holdings portfolio might be almost identical to an ETF or Mutual Fund portfolio.

Details:
A closed-end fund is a publicly traded investment company that raises a fixed amount of money through an initial public offering (IPO). The fund then trades its fixed number of shares like a regular stock in the market. CEF’s normally have a specialized portfolio of securities and all have active investment advisors.

Let’s compare a Mutual Fund with a CEF in our current market. If there is a market panic, investors may sell any particular stock or segment of stocks in masse. With a huge wave of sell orders and needing to raise money for redemptions, the manager of an Mutual Fund may be forced to sell stocks he would rather keep, and keep stocks he would rather sell, because of liquidity concerns (selling too much of any one stock causes the price to drop disproportionately). By comparison an investor pulling out of a closed-end fund must sell it on the market to another buyer, so the manager need not sell any of the underlying stock.

Closed-end funds are designed to pay investors a set monthly or quarterly distribution. With more and of us either reaching retirement age or retired, a steady income stream is increasingly important. Since the CEF is market price driven, not necessarily the NAV, unlike Mutual Funds. For example, a CEF with a 10% discount to NAV means a CEF is paying you 10% more than you would get if you bought the same stock portfolio directly. You can buy a $1,000 worth of stock for only $900, and get a healthy dividend.

My current CEF’s:

BSL
Blackstone/GSO Senior Floating Rate Term (BSL) sells for a 4% discount to NAV. With a current yield of 7.5% and a maturity of 4 years due to mandatory liquidation in 2020. Therefore Blackstone/GSO Senior Floating Rate Term (BSL) has an effective yield to maturity of nearly 12%. With this great dividend and a fixed repayment date, this can be an attractive place to ride out a rough market while waiting for interest rates to rise. This CEF pays dividends monthly.

JPC
Nuveen Preferred Income Opportunities Fund invests in Preferred Stock shares, another of my favorite, conservative sectors. It trades at a 1% discount to NAV and generates 8% yield. This CEF pays dividends monthly.

BUI
BlackRock Utility and Infrastructure Trust (BUI): I like this CEF because no matter who wins the election in November, the demand for water, energy and improved roads and bridges will keep need to be addressed. This CEF sells for a 1% discount to NAV and has a 7% yield. This CEF pays dividends monthly.

On my shopping list is:

GAB
Gabelli Equity Trust GAB) is has very diversified portfolio. It has a 11% yield and sells at a 4% discount to NAV. It top 10 holdings are pretty blue chip, Rollins, Honeywell, MasterCard, Swedish Match, Cablevision, Berkshire Hathaway, Twenty-First Century Fox, American Express, Genuine Parts and O’Reilly Automotive. This CEF pays dividends quarterly.

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