Similar to more-popular ETFs, closed-end funds hold baskets of securities, such as stocks or bonds. But, unlike with ETFs, the share prices of closed-end funds tend to diverge much more from the underlying value of their assets. As a result, closed-ends often trade well above or below their net asset value (NAV) per share. When a fund trades below its NAV, the discount is like a margin of safety, similar to buying a dollar's worth of assets for 90 cents. Ideally, you want to buy a closed-end fund when it sells at a discount to NAV and wait for that discount to narrow, or even turn into a premium, enhancing the returns you get from the performance of a fund's assets.
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- Bank Accounts: 1%-4%
- Municipal Bonds: 1%-3%
- Investment-Grade Bonds: 3%-5%
- Real-Estate Investment Trusts: 2%-6%
- Foreign Bonds: 3%-6%
- Preferred Stocks: 4%-7%
- High-Yield Bonds: 6%-8%
- Master Limited Partnerships: 5%-11%
Risks to your money. Many closed-ends borrow money to buy securities. That additional debt, which can exceed 30% of a fund's assets, pumps up the yield but can amplify losses. If interest rates increase, it can be a double-whammy: Many closed-end funds hold bonds and other interest-sensitive securities that would lose value, and the cost of their own debt would increase. One other caveat: Some funds aim to hit distribution targets each month, and if they can't meet their goal with income or investment gains, they pay out capital. Essentially, that means they may give investors some of their money back as distributions, a practice that can erode the share price over time.
Hire a pro. If you'd rather not pick individual funds, a couple of ETFs can do it for you. The PowerShares CEF Income Composite Portfolio (PCEF, $22, 8.3%) holds a basket of 145 income-oriented funds that invest mainly in corporate and high-yield bonds. It recently traded at an 8.9% discount to NAV. Encompassing a broader mix of funds, the YieldShares High Income ETF (YYY, $18, 10.6%) keeps about two-thirds of its assets in bond funds and the rest in stock funds. The ETF trades at a slight premium to its NAV. (All prices and returns are as of March 31.)
Do it yourself. Nuveen Muni Market Opportunity (NMO, $14, 5.4%) holds more than 90% of its assets in investment-grade tax-free bonds. It trades at a 9% discount to NAV--an attractive price for a high-quality mix of bonds, says John Cole Scott, chief investment officer of Closed-End Fund Advisors, an investment firm in Richmond. For top earners, the 5.4% tax-free yield is equivalent to 9.5% from a taxable security.
If you can handle more risk, go for Advent Claymore Convertible Securities & Income (AVK, $13, 8.5%). Holding convertible securities and other types of debt, the fund trades at a deep, 15% discount. Also compelling, says Scott, is Nuveen Diversified Real Asset Income (DRA, $16, 10.0%), which holds real estate investment trusts, preferred securities and bonds. The fund trades at a 15% discount to NAV.