Closed-end funds are among the most promising income opportunities available to investors today—yet they are often afterthoughts for advisors, retail investors and investment analysts alike.

After a decade of low interest rates, investment income is still difficult to come by. The S&P 500 offers a dividend yield that hovers near 2%. The 10-year U.S. Treasury bond offers investors less than 3% in annual interest.

But closed-end funds can offer juiced investment yields to investors through a number of their structural attributes. In these vehicles, asset classes like tax-free municipal bonds may yield over 5% annually. Taxable bonds and dividend-paying stocks may offer yields over 7%.

According to Closed-End Fund Advisors, a fee-based RIA in Richmond, Va., the average closed-end fund was up 11.8% in the first quarter of 2019 (it fell 8.7% in the fourth quarter of 2018). The average equity closed-end fund in the first quarter was up 14.8%, besting the S&P 500’s 13.7%.

Closed-end funds issue a fixed number of shares to investors and do not issue new shares after their inception, in contrast to open-ended funds in which shares are continuously issued or redeemed according to investor demand. “Closed-end funds have always had income as their No. 1 goal,” says Jonathan Isaac, director of product management at Eaton Vance. “There are features inherent within the closed-end fund structure that help with that goal.”

Eaton Vance’s most popular closed-end fund is its $2.46 billion Eaton Vance Tax-Managed Global Dividend Equity Income Fund (EXG), but Isaac also held up the firm’s lineup of floating-rate bank loan funds as good examples of the opportunities in closed-end funds. Floating-rate leveraged loans tend to return less than conventional bonds, but can be used as a hedge against rising rates.

“These are floating-rate loans of the underlying investments, which people kind of flock towards when they believe short-term rates are heading higher,” says Isaac. “They do still work when the Fed goes on hold or doesn’t feel like there are prospects for higher short-term rates. What a lot of people don’t think about is that they’re getting a perfectly attractive distribution at current levels.”

Because closed-end funds don’t have to offer redemptions or offer new shares, their trading prices fluctuate independently from the value of the underlying assets. If the share supply exceeds investor demand, the market price becomes discounted to the fund’s NAV. If the investor demand exceeds share supply, the closed-end fund’s shares will trade at a premium.

Fewer than 500 closed-end funds exist today, with approximately $222 billion in market capitalization. The best argument for buying a closed-end fund is the income—any benefit offered by capital appreciation in these funds’ net asset value or change in their premium or discount may be best thought of as a bonus. Because the market price of a closed-end fund deviates from its NAV, investors are able to buy a stream of income at a lower price.

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