Whenever I write about how investing in bond funds is a losing strategy, I always receive emails asking, “What about closed-end bond funds?” My answer is an admittedly unsatisfying “it depends.”
For those who are unfamiliar with closed-end funds, here’s a brief primer…
A closed-end fund is like a mutual fund, except it trades very differently.
A mutual fund trades only at its net asset value (NAV) at the end of the day.
So if a mutual fund has $100 million in assets and 10 million shares outstanding, it will trade for $10 per share. If the next day its assets climb to $105 million, the fund will trade at $10.50.
A closed-end fund trades like a stock. Just like the stock of a regular company has a book value per share and will trade above or below that book value, the same goes for a closed-end fund.
But with closed-end funds, the book value per share, or in this case the NAV, will be an important metric to consider.
Because closed-end funds trade like stocks, they will trade higher than the NAV (at a premium) or lower (at a discount).
For example, say that a closed-end fund has $100 million in net asset value and 10 million shares. Its NAV is $10 per share. But the closed-end fund may be trading at $10.50, which would be a 5% premium.
In other words, you’re paying $1.05 for every $1 in assets.
On the other hand, if the closed-end fund were trading at $9.50, it would be trading at a 5% discount. So you’d pay only $0.95 for every $1 in assets.
This is an important thing to consider because the fund could perform well while its price does not. The NAV could rise, but the discount could steepen.
Theoretically, as the NAV rises, so should the price; and the discount should shrink, or the premium should increase. But it doesn’t always work that way.
Back to my opinions on closed-end bond funds…
Closed-End Funds in Today’s Environment
As I mentioned in a previous article about bond funds, I don’t like them in this low interest rate environment, even if they have attractive yields.
That’s because when interest rates eventually rise, bond funds will lose value. So the NAV of closed-end bond funds should decrease as well.
That being said, not all closed-end bond funds are created equal. Some hold convertible bonds, which convert into stock. Some own variable-rate loans, whose interest rates will rise if rates in general do the same.
Some trade at steep discounts, hedging some of the risk of declining NAV.
For example, one closed-end bond fund that I like is the Nuveen Floating Rate Income Fund (NYSE: JFR). It is a current recommendation in my Oxford Income Letter’s Retirement Catch-Up/High Yield Portfolio.
The fund invests mostly in adjustable-rate senior loans. At least 65% of the loans must be secured with collateral.
It yields 7.8%, pays a monthly dividend and trades at a sharp 13% discount. That means you’re buying assets for $0.87 on the dollar.
That’s a nice buffer in case NAV doesn’t move. In fact, you could get a nice return if the discount tightens even if NAV stays flat. Of course, the opposite can happen too.
But I like the fund’s steep discount, monthly dividend and high yield.
If you’re looking for a closed-end bond fund, I’d consider only those that are trading at steep discounts. You certainly don’t want to buy an overvalued fund in this low rate environment.
[adzerk-get-ad zone="245143" size="4"]About Marc Lichtenfeld
Marc Lichtenfeld is the Chief Income Strategist of Investment U’s publisher, The Oxford Club. He has more than three decades of experience in the market and a dedicated following of more than 500,000 investors.
After getting his start on the trading desk at Carlin Equities, he moved over to Avalon Research Group as a senior analyst. Over the years, Marc’s commentary has appeared in The Wall Street Journal, Barron’s and U.S. News & World Report, among other outlets. Prior to joining The Oxford Club, he was a senior columnist at Jim Cramer’s TheStreet. Today, he is a sought-after media guest who has appeared on CNBC, Fox Business and Yahoo Finance.
Marc shares his financial advice via The Oxford Club’s free daily e-letter called Wealthy Retirement and a monthly, income-focused newsletter called The Oxford Income Letter. He also runs four subscription-based trading services: Technical Pattern Profits, Lightning Trend Trader, Oxford Bond Advantage and Predictive Profits.
His first book, Get Rich with Dividends: A Proven System for Earning Double-Digit Returns, achieved bestseller status shortly after its release in 2012, and the second edition was named the 2018 Book of the Year by the Institute for Financial Literacy. It has been published in four languages. In early 2018, Marc released his second book, You Don’t Have to Drive an Uber in Retirement: How to Maintain Your Lifestyle without Getting a Job or Cutting Corners, which hit No. 1 on Amazon’s bestseller list. It was named the 2019 Book of the Year by the Institute for Financial Literacy.
