Closed End Bond Funds

Keith Kohl

Written By Keith Kohl

Posted November 17, 2008

Dear Energy and Capital Reader,

"Keith, you really have to take a look at this new investment."

Early this morning, my colleague Steve Christ drew my attention. During my morning grind, I typically become a recluse in my office and focus on the task at hand.

Today was different, and the reason is simple enough.

I’ve personally seen how Steve’s investment ideas have kept his readers’ portfolios afloat during this tumultuous market. While you are wincing as your portfolio dives into the red, Steve has been looking for those safer plays that deliver the gains.

As soon I read his thoughts on closed-end funds I instantly knew I would regret it if I didn’t share this with my Energy and Capital readers. In his latest piece, Steve gives you the inside scoop on how to trade these funds.

Good investing, 

Keith Kohl 
Editor, Energy and Capital


As the recent bear market has shown us, winning in the stock market isn’t always easy.

The truth is it takes patience, savvy, and a certain level of market smarts if you want to invest in the markets these days. And the cold hard reality is that if you don’t have them, the big boys will drain your portfolio dry.

Unfortunately, of course, those are three areas that nearly every retail investor needs the most work on.

But what if I told you there was one type of investment that actually takes the mystery out of its real value—-one that actually has price tag on it and can be safely bought when it goes on sale.

Would you be interested?

Because if you are, I can tell you that this type of investment is definitely no market unicorn. It is called a closed-end fund, and  it is an investment that trades on the exchanges every day.

Closed End Funds Explained

Now if you understand the idea behind a mutual fund, understanding a closed-end fund is easy. In essence, they are the same thing— pools of money controlled by a professional money manger.

However, in contrast, a typical mutual fund is also what’s known as an open-ended fund. This means that the fund itself can issue as many shares as it needs to meet the demand on any given day. So the total number of shares in this type of fund isn’t fixed at all—hence the term open ended. Shares are added as needed.

As a result, the cost of any share in one of these funds is always bought or sold at its current Net Asset Value (NAV).  That’s why shares of open-end funds don’t trade per se on the exchanges. Instead, their price tag is always set at end of the day and it always equals the net asset value of the underlying holdings……no matter what.

That means that in a broader sense the underlying assets of an open-ended fund can never be bought at a discount.  It is what is.

A closed-end fund on the other hand is totally different. Unlike an open-ended fund, closed-end funds issue a limited number of shares. That means the number of shares outstanding in them is fixed.   So closed end funds trade like a stock, bought or sold minute-by-minute with a price driven by market sentiment.

That’s a key difference and why I say closed end funds can be bought on sale.

Here’s why.

Because the market value of a closed end fund  share changes throughout the day, its price doesn’t necessarily reflect the net asset value of its holdings. In fact, it rarely does.

As a result, share prices of these funds trade at either a discount or a premium to the securities underlying them. And when they trade at a discount to their NAV they have essentially gone on sale, taking some of the guess work out of buying them.

Now in "normal" conditions, the typical closed-end fund trades at anywhere from a 2 to 10 percent discount to its net asset value. However, in today’s volatile environment of forced selling many these funds actually trade double-digit discounts now making them increasingly attractive investments.

Closed End Funds Meet Safe Harbor Savings Accounts

The most popular of these closed-end funds are those that invest in municipal bonds. They are the basis of what I call "Safe Harbor Savings Accounts." In them, you will find not only find a hefty yield, but very little risk.

But that’s not the best part about these closed-end funds.

Better yet, the interest from "Safe Harbor Savings Accounts " is exempt from federal income tax and in many cases, state and local taxes as well. So they provide an income stream the boys in D.C. can’t get their hands on unless you sell the bonds for a capital gain

That makes these ‘savings accounts" one of the easiest tax shelters on the market today—-especially now that they have hit the sales rack.

Consider, for instance, the Nuveen Insured Municipal Opportunity Fund (NIO:NYSE)

It is everything an investor could ask for these days. It pays a hefty yield and it’s safe.

But even better than that is this: because it is a closed end fund it’s currently on sale for an 11.77% discount. In other words, as of today, it will only cost investors, $11.17 to buy the underlying assets worth $12.66.

On top of that, this "savings account" pays a taxable equivalent yield of 8.80% for those buyers in the 28% tax bracket.

Just try to get that at a bank.

Of course, it is also a good bet that when the markets start to recover—and they will—that the discount on many closed-funds will return to "normal" levels. And when they do the share prices of these funds will rise right along with it.

That makes closed-end funds utilizing "Safe Harbor Savings Accounts" one of the best investments on the market today.

To learn more about "Safe Harbor Savings Accounts" click here.

Your bargain-hunting analyst,

steve sig

Steve Christ, Investment Director

The Wealth Advisory

P.S. While market turbulence continues to wreak havoc on investor portfolios across the globe, the Wealth Advisory is proudly sitting on a net gain of 286%. Simply follow this link to join the fast-growing Wealth Advisory community today, for as little as $79. 

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