Closed End Funds

While exchange-traded funds have dominated investment narratives, there is one relatively smaller asset class that offers investors unique and hidden potential.

Today’s edition explores the appeal of investing in closed-end funds, an active strategy that provides exposure to themes like international equities, infrastructure, and US equities.

These funds offer unique strategies, higher income, and active management strategies, which can help differentiate one’s investment portfolio. 

Closed-End Funds Still Relevant

The Indexing Revolution has had a massive impact on global equity markets, as passive indexing funds surpassed the value of actively managed funds in 2023.

This rise has sparked a debate among investors about whether active strategies, with higher management fees, are superior to low-cost passive strategies. Many traditionally actively managed funds have come under heat for their higher fees and underperformance.

However, there is a smaller slice of the actively managed fund space that is superiorly positioned in the current environment.

Closed-end funds offer investors the opportunity to invest in a variety of actively managed strategies and to invest in these assets at a discount to net asset value (NAV). In some cases, you can sometimes pay more than 10% less than the value of the assets of the fund, simply because of the limited supply of shares and lower interest from market participants.

As markets rally during bull runs, closed-end funds often have a history of outperforming, as the discount to NAV becomes smaller. Moreover, the yield for the fund can be higher if you invest in it at a discount to NAV.

This unique strategy has been strongly overlooked in the market, as the closed-end fund is still a small market with less than $700 billion in assets.

The closed-end fund market provides investors with unique opportunities to invest in US and international equities, as well as other strategies like infrastructure companies and fixed income investments.

Closed-End Fund Features

A closed-end fund is defined as a fund that raises a set amount of capital through an IPO and then does not offer additional shares to investors. This structure differs from exchange-traded funds and mutual funds, which can accept new investments on an ongoing basis.

Closed-end funds have the following characteristics, which make them a unique investment opportunity:

Trade on Exchanges: Closed-end funds trade at traditional stock exchanges, similar to stocks and exchange-traded funds.

Discount or Premium: Closed-end funds trade at a premium or discount to their NAV, as investors buy shares from each other. In many cases, investors can take advantage of the discount of closed-end funds and then sell when this discount tightens.

Management: Closed-end funds are often actively managed and can sometimes distribute larger dividends for investors. Investors who buy a closed-end fund at a discount can enjoy higher dividend income, relative to investments in traditional ETFs.

Intraday Trading: Shares are traded throughout the day, but these funds may have lower liquidity depending on the demand from investors.

Why You Should Consider Closed-End Funds

One of the main benefits of investing in a closed-end fund is to take advantage of the discount to NAV. In particular, investors can accumulate shares when market conditions are weaker, and then sell during bull markets when the discount to NAV becomes smaller. This strategy can allow investors to outperform the respective index and other passive funds.

Many closed-end funds offer high distribution rates, since investors are able to purchase the shares at a discount to NAV. Consequently, closed-end fund investing can be a solid strategy for investors who are searching for dividend income strategies.

Finally, many closed-end funds can also earn superior returns because of the active management strategies, which select stocks based on unique factors like financials and growth potential.

CEFs to Check Out

There are a variety of closed-end funds that investors can check out, including domestic equity, international equity, infrastructure, and fixed income funds.

Closed-end funds that invest in US equities can be a solid strategy because of the fund’s discount and the active management strategies. The Eaton Enhanced Equity Income Fund (EOI) is an actively managed fund that invests in leading US equities that the fund managers believe have above average earnings growth potential.

Closed-end funds that invest in international equities are also viable options that often trade at a deep discount to NAV during market pullbacks. For example, the India Investment Fund (IFN) trades at a 10.4% discount to NAV, while the China A Share Fund (CAF) trades at an 11.2% discount to NAV.

Investing in infrastructure closed-end funds can also be a safe bet, especially during weaker economic cycles. The Cohen & Steers Income Fund (UTF) invests in a variety of infrastructure projects, including utilities, pipelines, toll roads, airports, ports, and other infrastructure companies.

Fixed-income investments are also a great way to diversify from US equities and earn more stable returns in the market. The PIMCO Corporate & Income Strategy Fund (PCN) invests in a variety of debt instruments, including US government related debt, non-agency mortgages, commercial mortgage-backed securities, high credit yield, and emerging markets. This fund has had an average return of 10.8% since its inception.

These are just a few of the types of closed-end funds out there, which can help investors diversify their assets and take advantage of unique actively managed strategies.