Renewed Interest in Closed-End Funds

Closed-end mutual funds are enjoying a peak in interest, according to The Wall Street Journal.

Fund companies are revamping these funds investment strategies and providing new offerings.

“It’s unbelievable. I don’t think anyone ever dreamed of $3, $4 or $5 billion dollar funds,” said Mariana Bush, a closed-end fund and ETF analyst at Wachovia Securities.

The reason for the peaked interested is that closed-end funds, like exchange-traded-funds, trade on exchanges and they can have many variations in structure and investment approaches.

Closed-end fund providers have come up with innovative ways to seek out better yield, as certain bond yields have decreased over the years. However, some of the new strategies can be complex and sometimes risky.

“All of these funds are manufacturing yield,” said Dennis Emanuel, managing director of closed-end fund and ETF research at Citigroup Investment Research. However, certain funds also “want to be as tax efficient as possible,” which is “not simple to do,” he said. 

One trait of closed-end funds is their tendency to trade at a discount to the underlying portfolio, which is improving. Unlike a lot of mutual funds, which are constantly creating or redeeming shares, closed-end funds issue a fixed number of shares, meaning their price is set by supply and demand.

Last month, the average discount for all closed-end funds narrowed almost a full percentage point to 2.34%, which was the lowest discount in the past year. About 35% of such funds are trading at a premium, compared with about 20% in 2005, according to Lipper.

Closed-end fund providers are focusing on the strategy of searching out stocks that pay dividends. One goal is to take advantage of recent tax-law changes that can lower taxes on dividend income if funds hold the stocks for a certain amount of time.

Eaton Vance Tax Managed Global Diversified Equity Income Fund uses this new tactic and the fund launched at $5.5 billion in February and was the largest closed-end fund in IPO history. It was the third largest IPO at the New York Stock Exchange.

However, these tactics come with risks. Too much pressure can force such dividend-paying stock prices to ruse, Bush said in a February report. Also, tax laws could change in the future.