Income-seeking investors are always on the lookout for fresh opportunities to enhance their yield. Recently, DoubleLine CEO Jeffrey Gundlach has highlighted a reemerging opportunity in the form of closed-end funds. These funds, a relative of traditional open-end mutual funds, trade on public exchanges and are available for trading throughout the day. One key feature of closed-end funds is their limited number of shares, which can lead to the share price trading at a discount or premium to the fund’s net asset value. Additionally, many closed-end funds utilize leverage, which can introduce volatility but also juice up returns.
Gundlach emphasized the attractiveness of closed-end funds in the current market environment on CNBC’s “Closing Bell.” He pointed out that it is a “pretty good environment for moderate risk assets.” Retail investors can benefit from the fact that closed-end funds are once again trading at discounts, with the added advantage of leverage, allowing for double-digit yields without taking on excessive credit risk. This presents a compelling case for investors looking to boost their income potential.
One of the drivers behind the discounts seen in closed-end funds, particularly those holding bonds, is the sharp spikes in yields. Bond prices and yields move inversely, so a rise in rates can negatively impact the prices of these bond holdings, leading to discounts in closed-end funds. For example, closed-end funds that hold municipal bonds may experience significant discounts. Municipal bonds are attractive to investors due to their tax-free income benefits. Funds like Abrdn National Municipal Income Fund (VFL) and Eaton Vance California Municipal Income Trust (CEV) are trading at discounts to their net asset value, providing investors with attractive distribution rates.
Cautionary Considerations
While the allure of discounted closed-end funds with high distribution rates is appealing, investors need to exercise caution when selecting these investments. A high distribution rate coupled with a declining share price could signal potential trouble for investors, as distributions may be eroding the fund’s net asset value. It is crucial to understand the sources of these payments within the fund and ensure their sustainability. Moreover, investors should be mindful of the fees associated with closed-end funds, as higher expense ratios can eat into long-term returns. Additionally, the use of leverage in closed-end funds can amplify returns but also increase downside risks, especially in a rising interest rate environment. Investors must carefully evaluate the extent to which leverage is being utilized by the fund.
Closed-end funds present an intriguing opportunity for income-seeking investors to enhance their yield potential. With discounts available in the market and the possibility of leveraging to boost returns, investors can explore this alternative investment option to diversify their portfolios and generate income. However, it is essential for investors to conduct thorough research, understand the risks involved, and carefully select closed-end funds that align with their investment goals and risk tolerance. By being mindful of the pitfalls and advantages of closed-end funds, investors can capitalize on this unique income-generating opportunity in today’s market landscape.