Out of the Box: Closed-End Funds — The Least Appreciated Asset Class
You see some article, almost every day, “This ETF has a 5.00%+ yield.” The tout is on here, and there is a very good reason for it. Wall Street is trying to make money, the old-fashioned way, by luring you into places that are very profitable for Wall Street. The reason this is true is that the managers, of the ETF’s, make money based upon how many dollars they manage. In other words, the more money they manage, the more money they make.
Well, this is not true in closed-end funds and so, there is very little promotion of this product. Almost all of the closed-end funds are listed on one exchange, or the other, just like Exchange Traded Funds (ETF’s), but the closed-end fund manager does not make one penny more, no matter the amount of money invested in them. They are the most overlooked, and under appreciated, of all the asset classes now, in my opinion.
With the 10-year Treasury yielding 2.05% and the 30-year Treasury yielding 2.54% you can still find double digit yields in some closed-end funds. Think of that! The risks, in these funds, are mostly that some fund cuts their dividend. However, I also point out that some funds can raise their dividends or pay special dividends at year-end. The other major risk is that there is a credit problem in their portfolios. Though, since most closed-end funds have a wide diversification of assets, this helps off-set the risk. No investments are risk-free, of course, but the risks must be appreciated along with the rewards.
Even more telling is the Bloomberg Corporate Bond Index which, over the past year, yields 3.36%. This is then compared to the Bloomberg American High Yield Index which, over the last 12 months, yields 6.13%. Not even close to double digit yields, on average, in either space.
There are many aspects to the closed-end funds, that I find appealing. One is that some of the closed-end funds have monthly dividends. This provides three definite positives, in my view. The first is that you are getting Compound Interest, as a result of the monthly dividend payments, which means that the actual yield is about 1.00% higher than the stated yield, if you re-invest the dividends. The second is that money rolls in every month so you have the opportunity to reinvest it in whatever looks the most attractive at the time, so you have lots of flexibility. The third is that you have money to use, if you need it, without relying on the vagaries of the markets which might cause you to take a loss, when you didn’t want to take one.
Monthly dividends mean that you have money to use for bills, a purchase, or other liabilities. As a matter of my own opinion, I think closed-end funds are very useful for retirees, pension funds, and other institutions that have a liability side to their balance sheets.
Now closed-end funds are complicated, no doubt. There is the Net Asset Value (NAV), the Indicated Yield, the dividend history, the composition of their portfolio and the quality of the manager of the fund. You also have to make sure that they are paying you out of profits, and not just returning your money. You also have to consider the leverage, regulated by law, that it cannot exceed 50%, but remember the leverage belongs to the fund, and not to you.
Another positive with these funds is that there is great diversity. There are bond funds, MLP or energy related funds, gold funds, Real Estate funds, technology funds, health care funds et al to choose from. Given most closed-end fund portfolios, you get diversification in the holdings of the fund, and you also have a diverse amount of funds to consider.
In a world that is almost devoid of yield, at this point, I bring the category of closed-end funds to your attention, for your consideration. With the central banks of the world holding down yields, for the foreseeable future, in my estimation, this asset class represents one place where you can find yield and in a relatively safe fashion, in my honest opinion.
There is nothing wrong with playing for appreciation. To buy a stock at 10 and hope that it goes to 20 is a proven strategy that can work, though sometimes it doesn’t. I am a quite conservative investor and I also find “Yield” to be an attractive alternative, or addition, to appreciation plays.
The problem is that it is quite hard to find “Yield” these days, with the central banks’ continuing their interventions. Therefore, I am suggesting closed-end funds for your consideration if you want some yield. They are complicated, and I have spent hours doing my own homework for some clients, but I think closed-end funds are worth your attention now, especially if income is one of your goals.
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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