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.