Closed-end funds, a relative of traditional mutual funds, offer an appealing opportunity for income-seeking investors. These funds trade on public exchanges throughout the day, have a finite number of shares, and may trade at a discount or premium to their net asset value. Leverage, a strategy used by many closed-end funds, can amplify returns but also introduce volatility. DoubleLine CEO Jeffrey Gundlach emphasizes the suitability of closed-end funds in a moderate risk environment, pointing to the discounts at which they currently trade. Retail investors can access double-digit yields with limited credit risk.
Discounts in closed-end funds, particularly those holding bonds, arise from factors such as sharp increases in yields. Bond prices and yields move inversely, with rising rates reducing the value of bond holdings. Closed-end funds specializing in municipal bonds, which offer tax-free income, exhibit notable discounts. For example, the Abrdn National Municipal Income Fund trades at a 15% discount to its net asset value, providing a distribution rate of 5.45%. California residents can benefit from closed-end funds investing in tax-exempt California municipal bonds, such as the Eaton Vance California Municipal Income Trust, which trades at an 11% discount and offers a distribution rate of 5.07%.
While discounts and distribution rates are attractive, investors should exercise caution when selecting closed-end funds. A high distribution rate coupled with a declining share price can indicate issues within the fund. It is essential to understand the sustainability of distributions and the underlying factors driving them. Additionally, expense ratios, which can exceed 1%, can diminish returns over time. Finally, investors should be aware of the potential impact of leverage, which can magnify both returns and downside in a rising interest rate environment.
