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Closed-end funds offer high yields and stability for the income investor.
Dividend investors aren’t much for risk, so we have a tendency to avoid investments that sound exotic or rare. Closed-end funds felt esoteric and weird to me for many years until I sat down and really studied them. Then I realized they aren’t so strange at all.
Whereas a stock usually represents an ownership position in a given company, a closed-end fund (or CEF) represents an interest in a portfolio of securities focusing on a specific sector, actively managed by an investment adviser. The price will fluctuate based on both market forces like a regular stock, and the underlying values of securities held by the fund. So it’s a stock-mutual fund hybrid. It also has a fixed number of shares with a high yield.
The other advantage is that some of these funds invest in sectors you just can’t get buying stocks or ETFs.
So what do you want to look for in a closed end fund? The primary rule is that it’s best to find one that is trading at a discount to the value of its underlying securities, or net asset value, but whose discount to NAV is shrinking. You don’t want to buy a basket of securities that is being priced below its underlying value, and that value is declining, because it suggests something is wrong with those underlying securities.
Instead, the idea is that you have found a value the market has overlooked and the assets are slowly finding their true value and returning to an equilibrium point. This way you get a little capital gain to enjoy along with your dividend.
Here are some of the more intriguing closed-end funds I’ve found that you might want to consider as part of your diversified portfolio.
The Eaton Vance Tax-Managed Buy-Write Income (NYSE:ETB) fund seeks current income with capital appreciation through investment in common stocks that seeks to exceed the total return performance of the S&P 500 Index and through utilizing a covered call and options strategy. ETB buys well-known names like Exxon Mobil (NYSE:XOM) and Coca-Cola (NYSE:KO) and sells calls against them. This closed-end fund trades at a 3.5% discount to NAV on average and has a high yield with a 6.8% distribution rate.
The Blackrock EcoSolutions Investment Trust (NYSE:BQR) drops 80% of its assets’ into stocks that tackle “New Energy,” water resources and agriculture, and it also uses options. This closed-end fund averages an 11% discount to NAV and has a generous distribution rate of 6%.
I like to keep things diversified, so I like the Western Asset High Yield Defined Opportunity Fund (NYSE:HYI), which focuses primarily on income, but also tries to yank some capital gains out of its strategy. It invests in high-yield corporate bonds across the maturity spectrum. This trades, on average, at a 9% discount to NAV, and I also like it because it distributes monthly rather than quarterly, to the tune of 6.2%.
My last choice is something I’ve been looking at very carefully for my own portfolio for its focus on commodities. The Blackrock Resources and Commodities Strategy Trust (NYSE:BCX) invests at least 80% of its assets in stocks issued by commodity or natural resources companies, derivatives with exposure to commodity or natural resources companies, or investments in securities and derivatives linked to the underlying price movement of commodities or natural resources. I found it difficult to find mutual funds that played the commodities markets and beat benchmarks while allowing the average Joe to buy in for a reasonable price, or to avoid paying insane fees. BCX pays out 5.75% and trades at an average of 13% discount to NAV.
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