Closed-end funds are complex beasts that are typically marketed by brokers to individual investors only when they're first launched. They carry fees of 5% or so to cover brokerage commissions and underwriting costs. Investors who buy newly minted closed-ends often fare poorly.
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But if you research closed-end funds carefully, you can do well. This article offers six closed-end funds that look attractive at current prices, as well as two RiverNorth funds that invest in them.
But first, what are closed-end funds? Think of a closed-end as a hybrid of a regular mutual fund and an individual stock. Like ordinary funds, closed-end funds invest in a portfolio of stocks or bonds or both. (About two-thirds of closed-ends invest only in bonds.) Like stocks, they generally issue shares only once, when they first go public. After they go public, they often trade at wide discounts or premiums to the value of the securities they own, known as their net asset value, or NAV, and typically expressed on a per-share basis. (Exchange-traded funds, by contrast, create and redeem shares constantly, so their share prices are usually close to their NAVs.)
Sentiment often swings wildly on individual funds. If you're patient, you can make money by exploiting the discounts and premiums—that is, buying a fund at a big discount and selling when the discount narrows or the fund goes to a premium. Keep in mind that fund prices usually revert not to their NAV but to their long-term average discount or premium.
The sector selling at the most compelling discounts just now: tax-exempt bond funds, especially those that use leverage (borrowed money), which boosts yields but also heightens volatility. These funds got creamed last year, causing many investors to flee and discounts to widen.
The picks below come from Patrick Galley, lead manager of RiverNorth Equity Opportunity R (RNEOX), a regular mutual fund that invests primarily in closed-end funds (more on RiverNorth later).
BlackRock Municipal Target Term Trust (BTT, current price $18.71; current yield, 6.0%; current discount to NAV, 6.1%) suffered a breathtaking loss of 22.4% last year because it invests in long-term bonds, which are especially vulnerable to rising interest rates (bond prices move inversely with yields). It leverages 44% of its assets and saw its share price go from a small premium to NAV to a discount to NAV. So far this year, by contrast, it has gained 10.0%. The fund will liquidate in 2030, and the average maturity of the bonds it owns is targeted to that date. If bond yields rise one percentage point, expect this fund to plunge 16%. (All share prices and discounts are as of February 5; unless otherwise stated, returns are through the same day and are based on changes in share prices.)
Nuveen Intermediate Duration Municipal Term (NID, $11.73, 5.8% yield, 10.3% discount) tumbled 19.3% last year thanks to 37% leverage, a widening discount and the effects of rising interest rates. It has gained 2.4% so far this year. The fund will liquidate in 2023.
Nuveen Municipal Advantage (NMA, $12.73, 6.3% yield, 10.8% discount) is 38% leveraged. It lost 15% in 2013 but has rebounded 5.3% this year. If yields rise by one percentage point, expect this fund to lose 11%. (Nuveen, incidentally, runs more than 40 municipal closed-ends, many of them similar.)
In taxable bonds, Templeton Global Income (GIM, $7.64, 5.5% yield, 7.4% discount) is intriguing. It's a near clone of Templeton Global Total Return (TTRZX), an excellent commission-charging mutual fund run by Michael Hasenstab. The unleveraged closed-end fund gives you access to Hasenstab's talents at a discount to NAV and without having to pay a load. Historically, the closed-end has traded at a premium to NAV. Finally, Galley recommends two venerable, low-fee stock funds:Adams Express (ADX, $12.20, 14.6% discount) and Tri-Continental (TY, $18.99, 14.2% discount), both of which launched in 1929. (Closed-ends were virtually the only kinds of funds until the Great Depression, and, partly because of their use of leverage, played a big role in the 1929 crash.) Adams, an unleveraged large-company stock fund, outpaced Standard & Poor's 500-stock index slightly over the past 15 years. Its 14% discount has remained in place for many years, with only minor variations.
Tri-Continental, which is just slightly leveraged, has about two-thirds of its assets in stocks and the rest in convertible bonds, regular corporate bonds, preferred stocks and cash. It has a stubborn 14% discount. Returns had been mediocre but have improved markedly since 2010, when the fund got a new manager.
Why bother with the stock funds? If investors really do rotate increasingly out of bonds and into stocks, Galley posits, these funds should produce solid returns. That might result in their discounts shrinking, at least temporarily, giving shareholders a double benefit.
RiverNorth runs several funds that, with the aid of computer algorithms, attempt to turn profits from ever-changing discounts on closed-end funds. A panic such as the one that hit muni bonds last year is their bread and butter. When the managers can't find good value, they sensibly stay in broad-based, index-tracking ETFs. Most of the RiverNorth funds also hire a well-known subadviser to run part of the assets.
RiverNorth/Oaktree High Income (RNOTX) is the only way I know for individual investors to invest in a bond fund run mainly by Oaktree, which specializes in high-yield debt. (Oaktree does run Vanguard Convertible Securities (VCVSX), a wonderful fund that, as the name suggests, invests in convertibles.) The RiverNorth fund, which launched at the end of 2012, returned 5.0% over the past 12 months. Oaktree runs three-fourths of the fund's assets; the rest are in closed-end funds chosen by RiverNorth.
RiverNorth Equity Opportunity invests in closed-end stock funds, including some that hold foreign stocks. Launched in mid 2012, it returned 13.1% over the past year.
One big stumbling block with RiverNorth funds: They charge too much. RNOTX charges 1.93% annually and RNEOX charges 2.17% annually, partly because of the extra layer of expenses from the closed-end funds RiverNorth owns. I think that Galley and company, as well as Oaktree, have the smarts and discipline to overcome their high expense ratios, but the fees do pose a high hurdle.
Steven T. Goldberg is an investment adviser in the Washington, D.C., area.
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