Investing For The Long-Term With Closed-End Funds

While investors notice the daily ups and downs of the market, the vast majority are more concerned with one goal: preparing for the long term.

In a recent Forbes Insights survey of 1,018 investors, almost three-quarters cited retirement security and income as a primary investment goal.

The next most cited goal: wealth preservation.

These concerns are nearly identical across gender, wealth level and whether people use an advisor or not.

Closed-end funds, or CEFs, can help meet both objectives.

As investment products that own a basket of securities—from equities to bonds to commodities—they pay out the majority of the fund’s gains and income to shareholders.

The focus of nearly all CEFs, regardless of what they may invest in, is providing attractive regular income or distributions to shareholders, while fund managers concentrate on maintaining and building the net asset value of the fund over the long term.

Closed-end funds came into being in the U.S. in 1893, more than 30 years before the first mutual fund was formed in the United States. Today, there are more than 525 closed-end funds, some of which have management and performance histories that date back nearly a century. Many investors hold CEFs for long periods, and it is not unusual for shares to be handed down from one generation to the next, according to the Closed-End Fund Association.

Closed-end funds raise their investment capital at the IPO. Because of that, CEF managers don’t have to worry about attracting more capital after the IPO or holding cash aside to fund investor redemptions later on. That means they have greater freedom to pursue the fund’s strategy and long-term goals and be proactive, not reactive, in down markets.

CEFs can invest in the likes of alternative securities, real estate and private placements—categories that are often less liquid or difficult for investors to access. These types of securities pose higher risk, but some of that is offset by the greater returns such assets, historically, tend to produce and the fact that CEF managers can own the asset for as long as they find it attractive. This longer-term approach enables individual CEF investors to gain exposure to assets many could not access any other way and without the significant capital commitment demanded by a hedge fund or private equity fund.

More than many other investment vehicles, closed-end funds utilize the freedom to employ leverage as part of their strategies. Leverage—borrowing to gain greater investment exposure and potential opportunities—typically magnifies investment returns, leading to higher highs and lower lows. Over longer periods, however, CEF leverage has historically boosted income more than enough to compensate for the added cost and volatility that may accompany leverage in periods of rising rates. The use of leverage by funds to increase potential returns is “appealing” or “extremely appealing” to 65% of investors surveyed by Forbes Insights.

There are CEFs to fit a wide array of investment styles and goals too. There are five broad types of CEFs—domestic equity, international/global equity, tax-free bonds, taxable bonds and international bonds.

Those looking to weather periods of market volatility while still investing for a longer time horizon can invest in funds using covered calls, which generate income and reduce the portfolio’s volatility risk by selling call options on some or all of the portfolio’s underlying stock holdings. Market volatility is the foremost concern of investors as they look ahead through the next 12 to 36 months, according to the Forbes Insights survey.

Investors can also select closed-end funds focusing on municipal bonds, emerging market currencies, mortgage-backed securities, master limited partnerships and more.

One feature to note about CEFs is that they frequently trade at a discount, or sometimes a premium, to the fund’s net asset value. This is because CEF shares trade on an exchange at prices determined by market supply and demand, similar to a stock. While purchasing fund shares at a discount can offer opportunities to potentially profit from share price appreciation, investors should be aware that discounts may not narrow and share prices may not rise.

Ideally, closed-end funds are for long-term-focused investors who are seeking attractive regular monthly or quarterly distributions.

The Forbes Insights survey shows this to be the case: More than half of investors say discounts and premiums don’t matter or are a minor factor for them when thinking about a closed-end fund. Income, diversification and the possibility of capital appreciation are three things investors say are much more decisive factors in their minds when considering a closed-end fund.


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