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Closed-end funds are considered a market paradox. Unlike more popular ones such as open-end mutual funds or ETFs, they offer a fixed number of shares. Therein lies a strategic, if not unconventional, advantage for intrepid investors.
Similar to ETFs, closed-end funds (CEFs) offer exposure to a basket of stocks, and choices vary by investment style, geographic allocation, asset class, and more. All CEFs are actively managed.
They are similar to stocks and mutual funds, but different from ETFs. A closed-end fund will first offer its shares through an IPO. The Fund issues a fixed number of shares. Also, unlike ETFs, CEFs do not accept additional capital inflows or issue new shares after an IPO. Therefore, the pricing of these funds depends on the supply and demand of these fixed numbers of shares, so the funds trade at a premium or discount to their net asset value (NAV). CEFs trade at premiums and discounts, making them less liquid than ETFs.
CEFs frequently use leverage to increase returns. While this is great in good times, it poses higher potential risks in down markets.
Why closed-end funds?
With the stock market volatile, some investors prefer closed-end funds to index funds. The yields on these vehicles are attractive to investors who want to participate in the stock market, but also want to generate income during unpredictable price movements across the stock market.
How to choose a closed-end fund
I first wanted to offer CEF options in three investment categories: pure stocks, pure bonds, and long/short strategies. After compiling a short list for each category, we narrowed each one down to funds trading at the smallest discount or premium. There is a large discrepancy (more than 10%) between price and NAV, which makes us uncomfortable regarding liquidity risk. And for me, liquidity is the most important factor in choosing investments.
We then looked at the amount of leverage being deployed by the top choices and shortened the list from there, selecting those with lower leverage. As mentioned above, leverage works well in up markets, but it can be a real pain in down markets.
As with any investment, it’s important to avoid considering one data point in isolation when comparing metrics between funds. For example, CEFs may be trading at a discount, but at first glance they appear to be undervalued. However, this may also reflect the market’s belief that the fund’s future value or income potential is at risk. Or maybe the fund boasts high returns, but that performance comes at the expense of extensive leverage.
The Forbes Braintrust crunched the numbers, conducted research, and did the analysis to find some of the best places to make money in 2024. Download one of Forbes’ most popular and widely anticipated reports: 12 Best Stocks to Buy in 2024.
1. Eaton Vance Enhanced Equity Income Fund (EOI)
- Style: Large Cap/Mid Cap Stock Blend
- Assets under management (AUM): $691 million
- Current price: $16.80
- Base price: $17.43
- Premium/discount to NAV: -3.6%
- Number of possessions: 58
- Largest holding: Microsoft (9.6%)
- Expense ratio: 1.10%
- Dividend yield: 7.9%
- Latest dividend amount: $0.11
- Dividend payment pace: monthly
Fund overview
EOI is an experienced fund founded in 2004. Its primary investment objective is to provide current income, and its secondary objective is to increase the value of capital. Management also uses covered call options on individual stock holdings to increase revenue generation.
EOI’s management benchmarks the fund to the S&P 500. However, we are currently strategically focused on specific sectors, particularly technology, healthcare, and communications. Financials and real estate are underweight. The fund’s top 10 stocks account for nearly 44% of EOI assets.
Why I like EOI
With interest rates expected to fall by the end of 2024, a fund focused on income generation makes sense to me. We included EOI because it has been around since 2004 and has a proven track record covering a wide range of market environments.
Meanwhile, the company’s dividend has been very reliable, increasing by an average of 7.1% over the past five years, the highest growth rate among its peer group. To increase the fund’s yield, management uses covered calls, but without any leverage. And while these picks are for a long-term time frame, note that EOI’s price trend chart looks solid at the moment.
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2. Nuveen City Value Fund (NUV)
- Style: Municipal Bond
- Assets under management: $1.9 billion
- Current price: $8.54
- NAV: $9.33
- Premium/discount to NAV: -8.4%
- Number of possessions: 455
- Average coupon: 3.4%
- Expense ratio: 0.47%
Fund overview
Trading since 1997, NUV’s strategy is to generate federal tax-free income by investing in municipal bonds. Proceeds are distributed monthly to shareholders. This fund may not be applicable to many investors, as municipal bonds often have lower yields than taxable bonds of similar quality, as their income is often tax-exempt. Please note. For investors who like the idea of municipal bonds but can’t take advantage of the full tax benefits of tax-exempt bonds, there are a number of his CEFs that invest in taxable municipal bonds, which typically offer higher yields.
At least 80% of NUV’s assets under management are rated investment grade, and management uses inverse floating rate securities as leverage, comprising up to 10% of the portfolio. Currently, NUV is leveraged at about 1% of his AUM.
The fund benchmarks its performance against the Standard & Poor’s (S&P) National Municipal Bond Index. Currently, NUV is diversified across all industry sectors, but has the greatest weighting in general obligation bonds and debt in the transportation and utilities sectors.The fund’s top 10 stocks account for approximately 12% of its assets under management..
Why I like NUV
In times of cyclical market uncertainty such as the one we are currently experiencing, investing in high-quality securities such as municipal bonds can reduce an investor’s risk. Nuveen has been doing this for over 30 years through the NUV Foundation. My favorite part is that leverage usage is limited (currently around 1%). Other companies in the peer group have higher leverage, up to 20%.
Throughout the fund’s life, NUV has been a top performer in its category. I like this price because it is currently trading near a three-year low and at a slight premium to the 200-day moving average.
The Forbes Braintrust crunched the numbers, conducted research, and did the analysis to find some of the best places to make money in 2024. Download one of Forbes’ most popular and widely anticipated reports: 12 Best Stocks to Buy in 2024.
3. First Trust Income Long/Short Fund (FSD)
- Style: Long/Short Bond Fund
- Assets under management: $573 million
- Current price: $11.84
- NAV: $12.72
- Premium/discount to NAV: -6.9%
- Number of possessions: 409
- Long/short exposure: 88.9%/11.1%
- Distribution rate: 10.6%
- Expense ratio (sales): 1.15%
Fund overview
FSD, which has been trading since 2010, has two investment objectives. The first is to generate current profits and the second is to achieve capital growth. To do this, management acquires both long and short positions in U.S. and non-U.S. debt securities. These include high-yield corporate bond products of various maturities. All of these securities were rated below investment grade at the time of purchase. FSD’s portfolio can contain up to 30% of its assets in short positions. Currently, that allocation is around 11%.
Long positions are taken in bonds that are believed to outperform the fund’s benchmark, the ICE BofA US High Yield Constrained Index. Conversely, management takes short positions in securities that it believes will underperform.
At first glance, note that FSD has an expense ratio of 4.23%. This is many times higher than any number I’ve ever seen. However, operating costs account for only about a quarter of that. The remaining 3% is the cost of using leverage. This is essentially the cost of doing business using leverage to increase profits. This is also the cost of hedging, so there is a give-and-take situation when it comes to the cost of funds like FSD.
Why I love FSD
The typical retail investor, i.e. a non-qualified purchaser, typically does not have access to a total return long/short strategy such as that offered by FSD. Since this is an “alternative asset”, it requires deeper research and scrutiny by all investors. FSD pays a monthly dividend and its yield is higher than its peers.
I also like the sector exposure nature of FSD. Currently, energy is too fat. I see this as a favorable long-term allocation as the energy industry gears up for a comeback. Limited supply, healthy demand and increased production investment are contributing to the positive outlook. A resurgence in the sector could lead to improved cash flow and higher debt returns, all of which are good for FSD. .
conclusion
We are currently in an environment of uncertainty regarding the direction of the market, the Fed’s interest rate movements, and whether we are facing a recession. In such a scenario, investors are looking for a reliable source of income. Closed-end funds offer higher yields than typical funds while allowing investors to make equity allocations across different styles and asset classes.
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The Forbes Braintrust crunched the numbers, conducted research, and did the analysis to find some of the best places to make money in 2024. Download one of Forbes’ most popular and widely anticipated reports: 12 Best Stocks to Buy in 2024.
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