High Yields and No Leverage

11/05/2008 1:00 pm EST

Focus: FUNDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of ISA ETF Investor, finds two closed-end buy write funds trading at nice discounts.

Leveraged closed-end funds (CEFs) have been through a number of crises in the past few months. The first was a freezing of the auction rate preferred market. Soon thereafter, the commercial paper market also began to freeze. This one was resolved when the government stepped in to guarantee liquidity in order to keep the market moving.

Now, a new one is looming. Closed-end funds that employ leverage use their holdings as collateral for short-term borrowing. A typical fund will have 30% leverage, [but] the leverage ratio cannot go above 50% without resulting in something akin to a margin call. As net asset values decreased with the market decline, some funds crossed the threshold. The immediate effect was a delay in the payment of the regular monthly dividend.

Closed-end buy-write funds also offer high yields without the use of leverage. They offer protection in two ways. The first is the effect of writing call options on the dividend-paying stocks in the portfolio. The second is the steep discount they are currently trading for.

These factors, along with their high yields, give the investor a triple layer of mitigation against a falling market. Of course, a continued falling market is going to sink equity funds no matter the mitigating factors.

The ING Global Equity Dividend & Premium Opportunity Fund (NYSE: IGD) is a global buy-write closed-end fund that holds dividend-paying equities, writes call options on them, and trades at a discount to its net asset value (NAV). The fund currently trades under $11 and its payout produces a yield of 17.4%. The current discount is 10.5%, greater than its typical 52-week average discount of 6.8%.

The decline in real estate investment trusts (REITs) has been sharp, reacting to the mortgage crisis and the associated financial meltdown. However, not all REITs are created equal. Sectors like health care, multifamily housing projects, and self-storage buildings are relatively less sensitive to the economic cycle.

The Neuberger Berman Real Estate Securities Income Trust (Amex: NRO) fund invests in REITs in defensive areas such as health care and multifamily projects. Common stocks of REITs are trading at a discount to the properties they own, a reversal of premiums evident just last year. [At Tuesday's closing price of $3.50,] this closed end fund trades at a 7.7% discount to its net asset value. In essence, a shareholder gets a portfolio of REITs that trade at a discount to their real estate value at yet another discount.

In addition to the double discount, the fund yields an astounding 52.6% paid monthly, but don't be surprised by a cut in this payout. Should the real estate market see a further decline, fund holders are doubly protected by the high yield and the double discount.

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