Jeffrey Gundlach, the CEO of DoubleLine, has recently highlighted a new opportunity for income-seeking investors – closed-end funds. These funds, which are a relative of traditional open-end mutual funds, trade on public exchanges and offer a limited number of shares. This limited availability can cause the share price to trade at either a discount or a premium to the fund’s net asset value, providing investors with a unique opportunity. Additionally, many closed-end funds utilize leverage, which can introduce volatility but also potentially increase returns for investors.
One of the key drivers of discounts in closed-end funds, especially those that hold bonds, is sharp spikes in yields. As bond yields and prices move inversely to each other, an increase in rates can lead to a decline in the prices of bond holdings within these funds. For example, closed-end funds holding municipal bonds, such as the Abrdn National Municipal Income Fund (VFL), are currently trading at a 15% discount to their net asset value. These discounts can provide income-seeking investors with the opportunity to acquire these funds at a lower price point, potentially enhancing their overall returns.
While the allure of double-digit yields may be enticing, investors need to be cautious when selecting closed-end funds for their portfolios. A high distribution rate coupled with a declining share price could signal underlying issues within the fund, such as distributions eating into the net asset value. It’s crucial for investors to understand what is driving the distributions within the fund and ensure their sustainability over the long term.
Additionally, investors should be aware of the fees associated with closed-end funds, which can exceed 1%. Higher expense ratios can erode returns over time, impacting the overall performance of the investment. Furthermore, the use of leverage by closed-end funds can enhance returns but also magnify downside risks. In a time of rising interest rates, the cost of maintaining leverage can impact the fund’s performance, making it essential for investors to carefully evaluate the extent to which leverage is utilized.
In the search for income-generating investments, closed-end funds can offer a compelling opportunity for investors looking to enhance their yield potential. By carefully examining the discounts, distribution rates, and underlying holdings of these funds, investors can make informed decisions that align with their investment goals and risk tolerance. While closed-end funds present unique challenges, they also offer the potential for lucrative returns when approached with a critical eye and a thorough understanding of the investment landscape.