Closed-end funds are considered a market paradox. They offer a fixed number of shares, unlike their more popular cousins like open-ended mutual funds and ETFs. Therein lies their strategic, if not unconventional advantages for the intrepid investor.
Like ETFs, closed-end funds (CEFs) offer exposure to a basket of stocks and the choices vary by investment style, geographic allocation, asset class and more. All CEFs are actively managed.
Similar to stocks and mutual funds, but less so to ETFs, closed-end funds first offer shares through an IPO, where the fund issues a fixed number of shares. Also unlike ETFs, after the IPO, CEFs do not accept additional capital inflows or issue new shares. As such, the pricing of these funds is dependent on the supply and demand for these fixed numbers of shares and thus the funds trade at a premium or discount to their net asset values (NAVs). Because CEFs trade at premiums and discounts they are less liquid than ETFs.
CEFs frequently use leverage to boost their returns, which is great during good times but poses higher potential risks during down markets.
Why Closed-End Funds?
In the midst of a volatile stock market, some investors prefer closed-end funds to index funds. The yields on these vehicles are attractive to investors who want to participate in the equity market, but also want income during times of unpredictable price movements in the broad stock market.
Methodology For Closed-End Fund Picks
I first wanted to provide you with a choice of CEFs in three investment categories: pure equity, pure bond and a long/short strategy. After gathering a short list in each category, I then narrowed each one down to the funds that are trading at the smallest discounts or premiums. Large discrepancies between price and NAV (more than 10%), make me uncomfortable when it comes to liquidity risk. And to me, liquidity is as valuable a factor in investment selection as anything.
Next, I looked at the amount of leverage deployed by my top choices and shortened my list from there, choosing those using lower amounts of leverage. As noted above, leverage works well in up markets but can really hurt on the downside.
Just like any investment, when comparing metrics between each fund, it is important to remember not to consider any one data point in isolation. For example, a CEF may be trading at a discount, which at first glance looks like it might be undervalued. However, it could also reflect the market’s belief that the fund’s future value or earnings potential is at risk. Or perhaps a fund boasts strong returns but that performance is coming at the cost of extensive leverage.
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1. Eaton Vance Enhanced Equity Income Fund (EOI)
Style: Large- Cap/Mid-Cap Equity Blend
Assets Under Management (AUM): $691 million
Current Price: $16.80
NAV: $17.43
Premium/Discount to NAV: -3.6%
Number of Holdings: 58
Largest holding: Microsoft (9.6%)
Expense ratio: 1.10%
Dividend yield: 7.9%
Latest dividend amount: $0.11
Dividend payout cadence: Monthly
Fund Overview
With an inception date of 2004, EOI is a seasoned fund. Its primary investment objective is to provide current income, with a secondary objective of capital appreciation. Management also uses covered call options on individual equity holdings to enhance income generation.
EOI management benchmarks the fund to the S&P 500. However it is currently strategically overweight to certain sectors, particularly technology, healthcare and communications. It is underweight to financials and real estate. The fund’s top ten holdings comprise almost 44% of EOI’s assets.
Why I Like EOI
Amid the anticipation of lower interest rates before the end of 2024, a fund focused on income generation makes sense to me. I included EOI because it’s been around since 2004, and therefore has a track record that covers a wide range of market environments.
Its dividends have been quite dependable over that time, increasing at an average of 7.1% over the last five years, a growth rate at the top of its peer group. To enhance the yield on the fund, management uses covered calls but does not employ any leverage. And, while these choices are for longer-term time frames, I will note that EOI’s price trend chart appears strong at this point.
2. Nuveen Municipal Value Fund (NUV)
Style: Municipal Bond
AUM: $1.9 billion
Current Price: $8.54
NAV: $9.33
Premium/Discount to NAV: -8.4%
Number of Holdings: 455
Average Coupon: 3.4%
Expense ratio: 0.47%
Fund Overview
Trading since 1997, NUV’s strategy is to generate federal tax-exempt income by investing in municipal bonds. The income is distributed to shareholders on a monthly basis. Note that this fund may not apply to many investors, since municipal bonds are purposely set to yield less than taxable bonds of similar quality, since their income is tax-free in many cases. For investors who like the municipal bond idea, but may not be in position to benefit fully from the tax benefits of tax-free bonds, there are many CEFs that invest in taxable municipal bonds that typically offer higher yields.
At least 80% of NUV’s managed assets are rated investment grade, and management uses inverse floating rate securities as leverage, which may comprise up to 10% of the portfolio. Currently NUV is levered at around 1% of AUM.
The fund benchmarks its performance against the Standard & Poor’s (S&P) National Municipal Bond Index. Currently, NUV is diversified among all industry sectors but is most heavily weighted in general obligation bonds and debt in the Transportation and Utility sectors. The fund’s top ten holdings comprise around 12% of AUM.
Why I Like NUV
During times of cyclical market uncertainty, such as what we’re experiencing right now, investing in higher credit securities like municipal bonds can mitigate investors against risk. Nuveen has been doing this for more than 30 years through the NUV fund. My favorite thing about it is its limited use of leverage (currently around 1%). Others in its peer group are leveraged much higher at up to 20%.
Over the lifetime of the fund, NUV has performed at the top of its category. Currently, I like the price as it’s trading near its three-year lows and at a tiny premium to its 200-day moving average.
The brain trust at Forbes has run the numbers, conducted the research, and done the analysis to come up with some of the best places for you to make money in 2024. Download one of Forbes’ most popular and widely anticipated reports, 12 Best Stocks To Buy for 2024.
3. First Trust Income Long/Short Fund (FSD)
Style: Long/Short Bond Fund
AUM: $573 million
Current Price: $11.84
NAV: $12.72
Premium/Discount to NAV: -6.9%
Number of Holdings: 409
Long/Short Exposure: 88.9%/11.1%
Distribution Rate: 10.6%
Expense ratio (operating): 1.15%
Fund Overview
FSD, which has been trading since 2010 has two investment objectives. Its first is to generate current income and its second is to achieve capital appreciation. To do this, management takes both long and short positions in U.S. and non-U.S. debt securities. These include high-yield corporate debt instruments of varying maturities. All these securities are rated below investment-grade at the time of purchase. FSD’s portfolio can contain up to 30% of assets in short positions. Currently that allocation stands at around 11%.
Long positions are taken in bonds that are believed will outperform the fund’s benchmark, the ICE BofA US High Yield Constrained Index. Conversely, management takes short positions in securities it believes will underperform.
Note that at first glance, FSD’s expense ratio shows at 4.23%, which is many times higher than what I’d ever look at. However, only about ¼ of that is from operating expenses. The other 3% is from the cost of employing leverage. That is essentially a cost of doing business in order to use leverage to try to boost returns. It is also a cost of hedging, so there is a give and take situation here regarding the costs of a fund like FSD.
Why I like FSD
Typical retail investors, i.e., unqualified purchasers, would normally not have access to a total return long/short strategy such as what FSD offers. This is an “alternative asset” and thus requires deeper research and scrutiny from all investors. FSD pays a monthly dividend and its yield is higher than those of its peers.
I also like the nature of FSD’s sector exposure. It is currently overweight in Energy. I view this as a favorable long-term allocation as the Energy industry is poised for a comeback. Limited supply, healthy demand, and rising investments in production have contributed to a positive outlook. A resurgence in the sector could translate into better cash flow and better returns on debt, all of which is good for FSD. .
Bottom Line
We currently live in an environment of uncertainty in terms of market direction, Fed moves on interest rates and whether or not we’re facing a recession. In such a scenario, investors are looking for a reliable source of income. Closed-end funds offer a higher yield than typical funds and at the same time allow investors to make equity allocations in a range of styles and asset classes.
Read Next
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The brain trust at Forbes has run the numbers, conducted the research, and done the analysis to come up with some of the best places for you to make money in 2024. Download one of Forbes’ most popular and widely anticipated reports, 12 Best Stocks To Buy for 2024.
