Closed-end funds (“CEFs”) can play an important role in a diversified portfolio as they may offer investors the potential for generating capital growth and income through investment performance and distributions. Over time, CEFs have evolved to include a variety of asset classes and investment strategies to accommodate the objectives and risk tolerance of a wide range of investors.
Potential for attractive distributions
Most CEFs pay distributions on a monthly or quarterly basis. In many cases, CEF distribution rates exceed those of comparable investment vehicles such as mutual funds. Investors generally have the option of receiving distributions in cash or having their distributions reinvested. By automatically reinvesting dividends, investors purchase additional CEF shares on an ongoing basis, which has the potential to lead to higher future returns.
Exhibit 1: CEFs may offer higher distribution rates than comparable investment vehicles such as mutual funds
Source: Lipper as of 5/31/2017. Past performance is not indicative of comparable future results. Municipal distribution rates use tax equivalent distribution assuming max 39.6% federal tax rate. Distribution rate is calculated by annualizing the latest monthly distribution and dividing that by the net asset value for mutual funds and share price for closed end funds on the as of date. Municipal is represented by the Lipper General & Insured Municipal Bond Category, General Bond is represented by the Lipper General Bond category, High Yield is represented by the Lipper High Yield category and Equity income is represented by the Lipper Options Strat/Options Arbitrage category. Distributions are sourced from net investment income, unless noted otherwise. This data is not meant to represent a specific investment.
Efficient portfolio management
Usually, once a CEF completes its initial public offering (“IPO”), the number of shares outstanding is fixed. Following the IPO, a CEF’s shares trade in the secondary market on a stock exchange and are usually not subject to redemptions by the shareholder. This means that portfolio managers can keep the fund fully invested and do not have to keep cash on hand to meet redemptions like they would in a mutual fund. This also provides greater flexibility in the types of securities and investment strategies portfolio managers can utilize, such as employing leverage to potentially enhance distributions and investing in more opportunistic and/or less liquid securities in seeking to generate higher returns.
Potential to enhance returns through leverage
Leverage is a strategy that can be employed by CEFs in an effort to achieve a higher rate of distributable income and potentially enhance returns. Leverage seeks to profit from the spread between short-term (lower) and long-term (higher) interest rates, assuming an upward sloping yield curve, by borrowing at short-term interest rates, or issuing preferred stock, and investing the proceeds in longer-term securities that typically pay higher rates of return. Although there are several potential benefits of using leverage, investors should consider the potential for increased risk and volatility prior to investing in a leveraged CEF.
Exchange traded liquidity
CEFs are typically listed on a major exchange such as the New York Stock Exchange. This provides the benefit of liquidity and the convenience of being able to track an investment with its assigned ticker symbol throughout the day. As a result, an investor can transact in CEF shares throughout the trading day at the current market price. This compares to a mutual fund, where an investor is limited to purchasing or selling the fund once a day at the close of business at NAV.
At any given point in time, a CEF’s share price may be above or below its underlying NAV, which is referred to as the CEF trading at a premium (market price is above NAV), or discount (market price is below NAV) to NAV. Premiums or discounts are the result of a combination of a number factors including, but not limited to, market and investor sentiment, fund specific characteristics, and/or manager and firm recognition. BlackRock believes that it may be advantageous to purchase a fund when it is trading at a discount to its NAV, as each dollar invested purchases more than a dollar of net assets. If the discount begins to narrow, investors may also have greater potential for capital appreciation.
- Phase in the market cycle
- Performance of the broad market
- Risk on/risk off sentiment
- Market view on interest rates and volatility
- Perception of fund performance
- Demand for investment strategy
- Year-end tax loss selling
- Distribution rate relative to peers
- Absolute/relative premium/discount
- NAV/market price performance
- Specific portfolio characteristics
- Level of novelty/access trade
- Secondary market liquidity
- Corporate actions
- Tax characteristics
Manager and firm recognition
- Fund sponsor/manager reputation
- Secondary market support
- Research coverage
This post was originally on BlackRock.com
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained visiting the iShares ETF and BlackRock Mutual Fund prospectus pages. Read the prospectus carefully before investing. Use of the tools and functionality provided is subject to the additional terms and conditions set forth on this site.
Performance data quoted represents past performance of common shares and does not guarantee future results. Performance is net of fees. Investment return and principal value of an investment will fluctuate so that an investor’s shares may be worth more or less than the original cost. The fund’s market price and net asset value will fluctuate with market conditions. All return data assumes reinvestment of all distributions. Current performance may be lower or higher than the performance data quoted.
Investment return, price, yields and NAV will fluctuate with changes in market conditions. At the time of sale, your shares may have a market price that is above or below net asset value, and may be worth more or less than your original investment. There is no assurance that a fund will meet its investment objective.
The closing price and net asset value (NAV) of a fund’s shares will fluctuate with market conditions. Closed-end funds may trade at a premium to NAV but often trade at a discount. CEF shares are bought and sold at “market price” determined by competitive bidding on the stock exchange. Net asset value (NAV) is the value of all fund assets, less liabilities divided by the number of shares outstanding.
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