Closed-end funds are complex beasts that are typically marketed
by brokers to individual investors only when they're first
launched. They carry fees of 5% or so to cover brokerage
commissions and underwriting costs. Investors who buy newly minted
closed-ends often fare poorly.
But if you research closed-end funds carefully, you can do well.
This article offers six closed-end funds that look attractive at
current prices, as well as two RiverNorth funds that invest in
But first, what are closed-end funds? Think of a closed-end as a
hybrid of a regular mutual fund and an individual stock. Like
ordinary funds, closed-end funds invest in a portfolio of stocks or
bonds or both. (About two-thirds of closed-ends invest only in
bonds.) Like stocks, they generally issue shares only once, when
they first go public. After they go public, they often trade at
wide discounts or premiums to the value of the securities they own,
known as their net asset value, or NAV, and typically expressed on
a per-share basis. (Exchange-traded funds, by contrast, create and
redeem shares constantly, so their share prices are usually close
to their NAVs.)
Sentiment often swings wildly on individual funds. If you're
patient, you can make money by exploiting the discounts and
premiums--that is, buying a fund at a big discount and selling when
the discount narrows or the fund goes to a premium. Keep in mind
that fund prices usually revert not to their NAV but to their
long-term average discount or premium.
The sector selling at the most compelling discounts just now:
tax-exempt bond funds, especially those that use leverage (borrowed
money), which boosts yields but also heightens volatility. These
funds got creamed last year, causing many investors to flee and
discounts to widen.
The picks below come from Patrick Galley, lead manager of
RiverNorth Equity Opportunity R (symbol
), a regular mutual fund that invests primarily in closed-end funds
(more on RiverNorth later).
BlackRock Municipal Target Term Trust (
, current price $18.71; current yield, 6.0%; current discount to
NAV, 6.1%) suffered a breathtaking loss of 22.4% last year because
it invests in long-term bonds, which are especially vulnerable to
rising interest rates (bond prices move inversely with yields). It
leverages 44% of its assets and saw its share price go from a small
premium to NAV to a discount to NAV. So far this year, by contrast,
it has gained 10.0%. The fund will liquidate in 2030, and the
average maturity of the bonds it owns is targeted to that date. If
bond yields rise one percentage point, expect this fund to plunge
16%. (All share prices and discounts are as of February 5; unless
otherwise stated, returns are through the same day and are based on
changes in share prices.)
Nuveen Intermediate Duration Municipal Term (
, $11.73, 5.8% yield, 10.3% discount) tumbled 19.3% last year
thanks to 37% leverage, a widening discount and the effects of
rising interest rates. It has gained 2.4% so far this year. The
fund will liquidate in 2023.
Nuveen Municipal Advantage (
, $12.73, 6.3% yield, 10.8% discount) is 38% leveraged. It lost 15%
in 2013 but has rebounded 5.3% this year. If yields rise by one
percentage point, expect this fund to lose 11%. (Nuveen,
incidentally, runs more than 40 municipal closed-ends, many of them
In taxable bonds, Templeton Global Income (
, $7.64, 5.5% yield, 7.4% discount) is intriguing. It's a near
clone of Templeton Global Total Return (
an excellent commission-charging mutual fund run by
. The unleveraged closed-end fund gives you access to Hasenstab's
talents at a discount to NAV and without having to pay a load.
Historically, the closed-end has traded at a premium to NAV.
Finally, Galley recommends two venerable, low-fee stock funds:Adams
, $12.20, 14.6% discount) and Tri-Continental (
, $18.99, 14.2% discount), both of which launched in 1929.
(Closed-ends were virtually the only kinds of funds until the Great
Depression, and, partly because of their use of leverage, played a
big role in the 1929 crash.) Adams, an unleveraged large-company
stock fund, outpaced Standard & Poor's 500-stock index slightly
over the past 15 years. Its 14% discount has remained in place for
many years, with only minor variations.
Tri-Continental, which is just slightly leveraged, has about
two-thirds of its assets in stocks and the rest in convertible
bonds, regular corporate bonds, preferred stocks and cash. It has a
stubborn 14% discount. Returns had been mediocre but have improved
markedly since 2010, when the fund got a new manager.
Why bother with the stock funds? If investors really do rotate
increasingly out of bonds and into stocks, Galley posits, these
funds should produce solid returns. That might result in their
discounts shrinking, at least temporarily, giving shareholders a
RiverNorth runs several funds that, with the aid of computer
algorithms, attempt to turn profits from ever-changing discounts on
closed-end funds. A panic such as the one that hit muni bonds last
year is their bread and butter. When the managers can't find good
value, they sensibly stay in broad-based, index-tracking ETFs. Most
of the RiverNorth funds also hire a well-known subadviser to run
part of the assets.
RiverNorth/Oaktree High Income (
) is the only way I know for individual investors to invest in a
bond fund run mainly by Oaktree, which specializes in high-yield
debt. (Oaktree does run Vanguard Convertible Securities (
), a wonderful fund that, as the name suggests, invests in
convertibles.) The RiverNorth fund, which launched at the end of
2012, returned 5.0% over the past 12 months. Oaktree runs
three-fourths of the fund's assets; the rest are in closed-end
funds chosen by RiverNorth.
RiverNorth Equity Opportunity invests in closed-end stock funds,
including some that hold foreign stocks. Launched in mid 2012, it
returned 13.1% over the past year.
One big stumbling block with RiverNorth funds: They charge too
much. RNOTX charges 1.93% annually and RNEOX charges 2.17%
annually, partly because of the extra layer of expenses from the
closed-end funds RiverNorth owns. I think that Galley and company,
as well as Oaktree, have the smarts and discipline to overcome
their high expense ratios, but the fees do pose a high hurdle.
Steven T. Goldberg
is an investment adviser in the Washington, D.C., area.