If you’re a conservative investor at or nearing retirement, income is probably high up on your hit list — and that’s why closed-end funds (CEFs)are worth looking into right now.
CEFs are similar to mutual funds in that you’re getting access to a portfolio of equities, bonds or other investments. Unlike mutual funds, CEFs issue a limited number of shares at their inception which then are traded on an exchange. As a result, CEFs can trade at a discount (or premium) to the value of the actual assets under management. And right now, many CEFs are trading at a discount.
But closed-end funds are not all the same — and investors hunting for CEF bargains must look past some eye-popping discounts and weigh other factors before going all in.
Income investors love CEFs because they can pay high distribution rates quarterly or even monthly — although those distributions can be comprised of dividends, capital gains or return of capital, and if so, they won’t be taxed as dividends, but as ordinary income, which has a higher rate.
For instance, some CEFs play interest-rate spreads, using leverage to boost distributions — a practice that adds to risk. Consider a municipal bond CEF with 30% leverage that pays a monthly distribution of 8%. While the CEF might be trading at a discount of 10% on the value of the municipal bonds under management, if interest rates rise, the value of the bonds falls — leverage deals out a double-whammy.
That doesn’t mean CEFs as a whole are bad — it just means that it pays to be choosy. So, here are three closed-end funds you can feel good about:
High-Yielding CEFs – Source Capital (SOR)
Distribution Rate: Quarterly, 4.7%
Total Net Assets: $671 million
Expense Ratio: 0.84%
If you’re looking for a closed-end fund that focuses on mid-cap growth stocks, Source Capital (SOR) is worth checking out.
As opposed to closed-end funds with holdings in hundreds of equities, SOR has the feel of a boutique, rather than a department store. SOR is focused on value: buying and holding quality small- and mid-cap stocks that can deliver long-term capital growth at a reasonable price. SOR’s portfolio includes only 32 stocks at present — including top holdings O’Reilly Automotive (ORLY, 9.3%), Signet Jewelers (SIG, 7.6%), Wabco Holdings (WBC, 6.1%) and CarMax (KMX, 5.9%) — and turnover is low.
SOR was launched back in the mid-1960s, and lead manager Eric Ende has been in charge since the 1990s. Although co-manager Steven Geist will retire at the end of this year, Greg Herr, who has been on the fund since 2007, continues as a co-manager.
SOR’s total distribution rate of 4.7% is lower than many other CEFs, but the SOR has steady returns to make up for that. SOR has returned 22.8% annualized in the past three years and 18.9% in the past five to outperform the S&P 500.
If you’re bargain hunting, SOR is trading at a discount of nearly 12% and has a reasonable total expense ratio of 0.84%, or $84 for every $10,000 invested.
High-Yielding CEFs – Western Asset High Income Opportunities Fund (HIO)
Distribution/Rate: Monthly, 7.09%
Total Net Assets: $550 million
Expense Ratio: 0.9%
If you are looking for a hefty distribution rate and have a risk tolerance for junk bonds, Western Asset High Income Opportunities Fund (HIO) might be a CEF to consider now.
One of the first things that comes to mind with HIO is the word bargain — this CEF currently is trading at a 7.1% discount.
Another bonus: Its 7.58% distribution does not include return of capital. Many closed-end fund distributions include ROC, meaning that some of the money you invest is actually being paid back to you, decreasing the value of your investment.
Eighty-four percent of HIO’s portfolio is in high-yield corporate bonds, with the top two concentrations in B-rated (41%) and CCC-rated (30.7%). Corporate debt that is rated below investment grade includes a higher risk of default, but the lack of leverage is comforting.
The 393 holdings of this closed-end fund are global — less than 4% of its holdings are in the U.S. Top industries represented in the portfolio are communications (15.7%), consumer cyclical (11%), energy (10.5%) and consumer non-cyclical (10%).
HIO’s annualized returns of 8.6% over the past three years and 11.4% over the past five lag the S&P 500, but do compare favorably to investment-grade bond funds over the period.
High-Yielding CEFs – Gabelli Equity Trust (GAB)
Distribution/Rate: Quarterly, 8.1%
Total Net Assets: $1.7 billion
Expense Ratio: 1.4%
If you believe that the bull market in stocks will continue running, Gabelli Equity Trust (GAB) is a good closed-end fund to buy now – even though shares currently are selling at about a 3% premium.
There are two key reasons GAB is a winning play even if it doesn’t deliver the discounts of some of its CEF peers. First, when it comes to value investing, it’s hard to beat rock-star fund manager Mario Gabelli, who founded GAB back in 1986 and has managed it ever since.
Second, GAB invests in stocks and other equity securities — 81% of its portfolio of about 400 holdings is comprised of North American stocks; 13.5% are focused on greater Europe with an eye toward value. Top holdings in the closed-end fund include American Express (AXP), Rollins (ROL), Honeywell International (HON), 21st Century Fox (FOXA), DirecTV (DTV) and Deere & Co. (DE).
GAB’s top three sectors are consumer services (25%), industrials (23%) and consumer goods (19%). Although GAB has gained a somewhat subdued 5.16% return year-to-date, it has recorded 24.4% and 20.7% annualized over the past three and five years, respectively.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.