It’s no secret that exchange-traded funds (ETFs) have taken the investment world by storm. The fund type is now home to more than $2 trillion in assets.
However, if you have a particular interest in income — especially of the high-yield persuasion — you might want to consider a different, less-ballyhooed type of fund: closed-end funds (CEFs).
CEFs trade throughout the day on exchanges just like ETFs and represent baskets of stocks, bonds or other holdings. But the kicker here is that unlike ETFs, which have a creation/redemption mechanism, closed-end funds issue a set number of shares when launched. The laws of supply and demand dictate what their value is. Essentially, what this means is you can buy $1 worth of stocks for, say, 95 or 90 cents. That’s built-in value.
CEFs also have the ability to use leverage to bolster distributions, which again makes them a great place to find big yields. And as an added bonus, many closed-end funds pay out their distributions on a monthly basis.
If you’re looking to add some extra oomph to your portfolio, you might want to consider one or more of these CEFs.
Closed-End Funds to Buy: Voya Prime Rate Trust (PPR)
Discount to NAV: 8%
PPR Distribution Rate: 6.4%
Reported Expense Ratio: 2.1%, or $210 for every $10,000 invested.
Given the long-feared potential for interest rates to finally come off the bottom, investors have been drawn to senior and floating-rate bank loans. These bonds have provisions that cause the interest rates charged to “float” every 30 to 90 days based on metrics such as Libor or the Fed funds rate.
This short duration makes them a perfect play on rising interest rates, and their high yields make them a friend to income seekers.
PPR spreads its $1.2 billion worth of assets across 310 different issuers. This CEF only focuses on senior loans, which represent the top tier of the bankruptcy ladder. These loans are often tied to pieces of working capital, like wireless towers or a pipeline. Thus, top holdings are tethered to household names such as PetSmart (PETM) or Clear Channel (CCO).
Currently, PPR can be had for a hefty 8% discount to its underlying value, which is far greater than its historical average. Meanwhile, distributions come in monthly, and currently work out to a 6.4% yield.
Closed-End Funds to Buy: Nuveen Municipal Value Fund (NUV)
Discount to NAV: 3.7%
NUV Distribution Rate: 4%
Reported Expense Ratio: 0.56%
Municipal bonds can be a haven for tax-sensitive and high-earning investors. Free from federal (and in some cases, state & local) taxes, munis are a great way to boost your income without having to pay Uncle Sam.
However, by buying at a discount and using a little leverage, you can squeeze a bit more yield out of munis than what you can get from a municipal bond ETF.
The Nuveen Municipal Value Fund (NUV) is one of the largest muni-focused CEFs at $2 billion in assets. The vast bulk of NUV’s holdings are in the bread ‘n’ butter “general obligation” category. However, the CEF does spice up things with a few revenue-oriented and special-purpose munis. This, plus NUV’s slight use of leverage (2%), helps produce a 4% yield.
While that might not seem like a mega-high yield at first blush, remember that the income is tax-free. If you were in the top tax bracket, you would have to get about 6.6% in yield to get an equivalent payout.
Meanwhile, NUV doesn’t take much off the top, charging just 0.56% to own.
Closed-End Funds to Buy: Credit Suisse High Yield Bond Fund (DHY)
Discount to NAV: 3.6%
NUV Distribution Rate: 10.3%
Reported Expense Ratio: 1.82%
While risky, high-yield (or “junk”) bonds are a great way to boost income while potentially gobbling up valuable capital gains as well.
Junk bonds — which are made to firms with less-than-stellar credit ratings — can produce stock-like returns with slightly less risk than equities, as in the case of a bankruptcy, debtholders must be paid off before shareholders. They’re a great place to get extra income … just don’t pile in too heavily.
CEFs and their extra leverage, though, allow investors to grab even more yield without risking more capital. The Credit Suisse High Yield Bond Fund (DHY) has leveraged about a third of its portfolio, and that leverage — along with junk’s already-high coupons — result in a mouth-watering 10%-plus distribution rate, paid monthly. Compare this to junk bond ETF iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which yields “just” 5.4%.
In short, you can double your potential yield in junk by playing DHY instead of a fund like HYG.
And as for the extra leverage risk? DHY’s discount to its NAV provides at least a little cushion for investors.
Closed-End Funds to Buy: John Hancock Tax Advantaged Dividend Income Fund (HTD)
Discount to NAV: 10%
NUV Distribution Rate: 6.9%
Reported Expense Ratio: 1.56%
Stock dividend income is a great way to help get you through retirement — especially considering most stocks’ dividends qualify for reduced (or nonexistent) tax rates.
Of course, with the S&P 500 yielding just under 2%, it’s not like you’re getting a ton in dividends, at least on average. But even many dividend-focused funds pay 3% to 4%.
Again, closed-end funds offer a sweeter solution.
The John Hancock Tax Advantaged Dividend Income Fund (HTD) distributes a delicious 6.9% to its investors. Naturally, leverage comes into play here; the fund features a 33% leverage ratio. As far as holdings go, this CEF features common and preferred shares of companies such as Interstate Power & Light, Wells Fargo (WFC) and BB&T (BBT) — the fund is heavy in utilities and financials — and HTD tends to be a buy-and-hold fund, helping to mitigate capital gains taxes.
Another big win for HTD is that it currently can be had for a nearly 10% discount to the underlying value of the stocks it holds — a slightly bigger difference than the three-year average discount of 9.3%.
As of this writing, Aaron Levitt was long HTD.