Closed-end funds (“CEFs”) can play an important role in a diversified portfolio as they may offer investors the potential for generating capital growth and income through investment performance and distributions. Over time, CEFs have evolved to include a variety of asset classes and investment strategies to accommodate the objectives and risk tolerance of a wide range of investors.
Potential for attractive distributions
CEFs typically pay distributions on a monthly or quarterly basis. In many cases, CEF distribution rates exceed those of comparable investment vehicles such as open-end mutual funds. Investors generally have the option of receiving distributions in cash or having their distributions reinvested. By automatically reinvesting dividends, investors purchase additional CEF shares on an ongoing basis, which has the potential to lead to higher future returns.
Exhibit 1: CEFs may offer higher distribution rates than comparable investment vehicles such as open-end mutual funds
Source: Lipper as of 8/31/2023. Past performance is not indicative of comparable future results. Municipal distribution rates use tax equivalent distribution assuming max 40.3% federal tax rate. Distribution rate is calculated by annualizing the latest monthly distribution and dividing that by the net asset value on the as of date. Municipal is represented by the Lipper General & Insured Municipal Debt (Leveraged) Category, General Bond is represented by the Lipper General Bond category, High Yield is represented by the Lipper High Yield category and Equity income is represented by the Lipper Options Strat/Options Arbitrage category. Loan is represented by the Lipper Loan Participation Category. Natural Resources is represented by the Lipper Natural Resources Category. Data reflects point-in-time averages for the respective open-end and closed-end categories, and is not meant to represent a specific investment. Distributions are sourced from net investment income, unless noted otherwise.
Efficient portfolio management
Usually, once a CEF completes its initial public offering (“IPO”), the number of shares outstanding is fixed. Following the IPO, a CEF’s shares trade in the secondary market on a stock exchange and are usually not subject to redemptions by the shareholder. This means that portfolio managers can keep the fund fully invested and do not have to keep cash on hand to meet redemptions like they would in a open-end mutual fund. This also provides greater flexibility in the types of securities and investment strategies portfolio managers can utilize, such as employing leverage to potentially enhance distributions and investing in more opportunistic and/or less liquid securities in seeking to generate higher returns.
Potential to enhance returns through leverage
Leverage is a strategy that can be employed by CEFs in an effort to achieve a higher rate of distributable income and potentially enhance returns. Leverage seeks to profit from the spread between short-term (lower) and long-term (higher) interest rates, assuming an upward sloping yield curve, by borrowing at short-term interest rates, or issuing preferred stock, and investing the proceeds in longer-term securities that typically pay higher rates of return. Although there are several potential benefits of using leverage, investors should consider the potential for increased risk and volatility prior to investing in a leveraged CEF.
Exchange traded liquidity
CEFs are typically listed on a major exchange such as the New York Stock Exchange. This provides the benefit of liquidity and the convenience of being able to track an investment with its assigned ticker symbol throughout the day. As a result, an investor can transact in CEF shares throughout the trading day at the current market price. This compares to a mutual fund, where an investor is limited to purchasing or selling the fund once a day at the close of business at NAV.
Premiums/discounts
At any given point in time, a CEF’s share price may be above or below its underlying NAV, which is referred to as the CEF trading at a premium (market price is above NAV), or discount (market price is below NAV) to NAV. Premiums or discounts are the result of a combination of a number factors including, but not limited to, market and investor sentiment, fund specific characteristics, and/or manager and firm recognition. BlackRock believes that it may be advantageous to purchase a fund when it is trading at a discount to its NAV, as each dollar invested purchases more than a dollar of net assets. If the discount begins to narrow, investors may also have greater potential for capital appreciation.
Exhibit 2: Some potential drivers of premiums and discounts
