Income on Sale: Closed-end Discounts

02/17/2016 9:00 am EST

Focus: FUNDS

Richard Moroney

Editor, Dow Theory Forecasts

Most closed-end funds offer high income on the cheap, but with a few notable twists. The 11 high potential funds featured here average distribution rates of 8.7%, explains Richard Moroney, editor of Dow Theory Forecasts.

Depending on a fund’s underlying holdings, distributions may include interest income, dividends, long- and short-term capital gains, and even return of capital.

Some managed-income funds pay a fixed amount, even if they don’t generate enough income to cover the obligation.

Closed-end funds trade throughout the day, with supply and demand setting their market price.

Among 560 closed-end funds tracked by Morningstar, 496 trade at discounts, meaning they are cheaper than their net asset value (NAV), the underlying value of the stocks and bonds in their portfolios.

In other words, as a result of these discounts, you can buy a dollar’s worth of assets for less than a dollar.

Factors such as a fund’s distribution rate, relative performance, trading liquidity, and potential tax liabilities from unrealized gains can impact the discount or premium.

On average, funds holding stocks trade at a discount of 10.1%, versus 6.2% for bond funds, according to Lipper.

Closed-end funds also report returns based on their net asset value (NAV). Importantly, when a fund’s discount narrows, the market-price return will exceed that fund’s NAV return.

For example, suppose you pay $8 for a fund with an NAV of $10, putting the discount at 20% or a $2 spread.

Assuming a year later the NAV climbs 10% to $11 and the spread narrows to $1, the market price would be $10, implying a return of 25%.

Many funds use leverage—or borrowed money—to enhance returns and boost income distributions. Notably, leverage can also increase a fund’s share-price volatility and expenses, and thus, its risk.

Listed below are 11 attractive income picks that trade at discounts to their recent net asset value.

Adams Diversified Equity (ADX)—8.3% yield and 17% discount
Adams Natural Resources (PEO)—8.8% yield and 17% discount
Blackrock Capital & Income (CII)—9.9% yield and 9% discount
Blackrock Floating Rate (BGT)—6.3% yield and 12.3% discount
Blackrock Ltd. Duration (BLW)—9.5% yield and 12.9% discount
Cohen & Steer Realty (RQI)—9.3% yield and 13.4% discount
Dreyfus Muni Income (DMF)—6.4% yield and 3.3% discount
Eaton Vance Dividend (EVT)—9.3% yield and 11.1% discount
Eaton Vance Enhanced Income (EOS)—9.1% yield and 6.4% discount
Eaton Vance Global Dividend (EXG)—12.8% yield and 11.6% discount
Reaves Utility (UTG)—6.8% yield and 6.8% discount

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