The market ups and downs of recent months can throw investors off their balance. It’s tempting to rush and shift portfolio holdings and call a bottom or a top to make up for paper losses or pursue quick gains. Many successful investors are being deliberate and planning for the long term.
Forbes recently surveyed 500 individual investors to learn how they are reacting in the aftermath of the Covid-19 pandemic. The survey found that most surveyed investors (56%) are focused on investing for retirement security and income. Short-term factors like “beating the market,” hedging and making short-term gains were the least important to individuals, noted by about one in five respondents.
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Survey findings highlight that these long-term investors are increasingly turning to an established, often-overlooked investing vehicle: Closed-end funds (CEFs). CEFs are investment products that own a basket of securities—from equities to bonds to commodities—which pay out nearly all of their income to shareholders. The focus of the vast majority of CEFs is providing regular income, called distributions, to shareholders, while at the same time fund managers concentrate on maintaining and building the net asset value (NAV) of the fund over the long term.
According to the fund information and screening site CEFConnect, there are 490 CEFs available to investors today. They provide a wide array of investment styles and goals, falling generally into five broad types of fund focus: U.S. equity, international/global equity, national and state municipal bonds, taxable bonds like corporates and internationals and hybrid funds. To generate income for shareholders, they can pursue a range of strategies, including leverage, using options, tax-efficient strategies and more.
Survey results suggest that almost two thirds (about 66%) of investors know about CEFs, are open to learning more or have discussed them with a financial advisor. In a Forbes Insights survey conducted in 2018, just 40% of individual investors said the same thing. Similarly, when presented with a list of seven CEF characteristics, investors were more aware of each one than they were in 2018.
“People who are living on monthly investment income clearly have been turning to closed-end funds,” says Sangeeta Marfatia, senior closed-end fund strategist at UBS Global Wealth Management.
Yet when compared to other types of fund investments, like mutual funds and exchange-traded funds, CEFs remain something of a secret to many. In the latest survey, 19% of investors said they didn’t know about CEFs. While that figure is down sharply from about 42% in 2018, it still means plenty of folks aren’t familiar with CEFs.
CEFs are one of the more established types of investment vehicles. Introduced to the U.S. stock market in 1893, CEFs pre-date mutual funds and ETFs, and some have been operating since before the Great Depression, according to MarketWatch. Investors held $278 billion in CEFs as of the end of 2019, compared to $239 billion a decade earlier in 2010, as reported by the Investment Company Institute.
One reason CEFs may be increasing in appeal is that their structure focuses on income generation and long-term growth. CEFs raise their investing capital at their IPO and after that, the funds are generally closed to new investors, and begin trading on an exchange where buyers and sellers transact with each other rather than the fund’s sponsor. That means fund managers don’t have to worry about attracting more capital down the line by issuing more shares (which could potentially dilute existing shareholders) and they also don’t need to worry about funding redemptions which can mean selling portfolio assets to meet these redemptions. For example, when mutual fund shareholders sell, the funds have to liquidate holdings to cash them out.
This insulation of the fund against investor inflows and outflows means CEFs have a relatively more stable pool of assets, enabling portfolio managers to pursue investments that may be less liquid and therefore offer higher potential returns such as alternative investments, real estate and private placements. It also allows them to stay more focused on strategy while taking advantage of longer-term opportunities. CEFs can and often do trade at a market price less than their NAV or sometimes more. That’s why they’re better suited for those who aim to hold for the long haul.
UBS’ Marfatia recommends that investors aim to understand the risks as well as the benefits associated with CEFs, especially how market volatility can affect NAVs and the ability for investors to sell large CEF positions into the market. “One: You're looking for income. Two: You're able to withstand the volatility that comes with it. And you have to be an aggressive investor to be buying a closed-end fund, especially taxable closed-end funds.”
CEFs provide access to assets that many investors could not access any other way and without the significant capital commitment demanded by a hedge fund or private equity fund. The latest survey found that more than 38% of investors want to find more value to add to their portfolio, 28% want to boost exposure to assets besides stocks and bonds and about the same percentage want to have more actively managed investments than they had pre-pandemic.
Planning for the long term and taking risks that are appropriate for you are valid guidelines for any investment. Investing isn’t a one-size-fits-all endeavor and CEFs may not be right for everyone. However, for those looking to generate income and diversify a portfolio against the market’s turmoil, CEFs appear to be beneficial. The survey results support this: 82% of investors who felt their portfolio was prepared for this year’s market volatility also own CEFs. One never knows what the future holds for the market, but as one of the oldest fund options, CEFs continue to show that they can help shrewd investors stand the test of time.
It is important to consider the objectives, risks, charges and expenses of any fund before investing. Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee a fund’s investment objective will be achieved. Closed-end fund historical distribution sources have included net investment income, realized gains and return of capital. Leverage typically magnifies the total return of a fund’s portfolio, whether that return is positive or negative, and creates an opportunity for increased common share net income as well as higher volatility of net asset value, market price, and distributions. There is no assurance that a fund’s leveraging strategy will be successful.
Nuveen Securities, LLC, member FINRA and SIPC
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