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Closed-end Funds

Closed-end funds (usually abbreviated as CEF) are a type of mutual fund (money pooled together by many investors to invest in a basket of stocks and bonds). Wikipedia has this to say:

"Typically an investor can acquire shares in a closed-end fund by buying shares on a secondary market from a broker, market maker, or other investor as opposed to an open-end fund where all transactions eventually involve the fund company creating new shares on the fly (in exchange for either cash or securities) or redeeming shares (for cash or securities).
The price of a share in a closed-end fund is determined partially by the value of the investments in the fund, and partially by the premium (or discount) placed on it by the market. The total value of all the securities in the fund divided by the number of shares in the fund is called the net asset value (NAV) per share. The market price of a fund share is often higher or lower than the per share NAV: when the fund's share price is higher than per share NAV it is said to be selling at a premium; when it is lower, at a discount to the per share NAV."

How does this work in practice?

Buying at Discount Strategy

Let us take the example of Cohen & Steers Infrastructure Fund (ticker symbol UTF). This fund invests in infrastructure companies all across the world. As I write this, it is trading at $14.95. On the other hand, its NAV is $17.33 (ticker symbol UTF). Thus the fund is trading at 86 cents to the dollar ($14.95 divided by $17.33) or a discount of 14%.

The fund currently pays out $0.24 per share every quarter (plus a once-a-year special dividend at the end of the year). That equates to $0.96 per year or a yield of 6.4% based on the market price. If you buy it at the NAV, the yield would have been only 5.5%. This is what attracts me to closed-end funds for generating passive income.

Resources

There are many websites that provide information about this relatively obscure corner of the market. Here are three to get you started:

Using CEFs for Passive Income

CEFs offer several options for implementing various investment strategies, such as Dividend Growth and High Yield investing. Buying a CEF at a discount allows us to get that little extra amount of income. Here are a couple of additional ideas:

Bond CEFs

There are many segments of the market that are offered as CEFs, such as

Emerging markets bonds such as MSD
High Yield bonds such as HYG
Convertible bonds such as CHY

IMPORTANT: It is easy to get tempted by the enormous yields you see reported by some of these CEFs. Make sure you drill deep and really understand where the yields are coming from and whether they are sustainable.

We will take a look at bond funds in a separate article.

Managed Distributions Plan

Then there are CEFs that invest in the "traditional" way (i.e. primarily for capital gains), yet pay out regular dividends (usually termed "distributions"). These distributions are usually paid out of long-term capital gains and dividends paid out by constituent companies. I recently came across a couple of stock CEFs (BTO and SOR) that came out with increased dividends as part of this so-called "managed distribution policy". This is yet another way of using CEFs for income.

Recap

There is a fair amount to learn here and the usual disclaimers apply: Do your due diligence and pay attention to risk-management (such as buying the right amount and using protective stops).

Return from Closed-end Funds to Dividends

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