Closed-End Income Funds
You have probably purchased open end income funds. These funds
typically invest in some type of bonds such as municipal, government
or corporate bonds. The price you pay for your shares is exactly
equal to the value of your share of the bonds in the portfolio.
And on any day, you can redeem your shares by selling them back
to the fund.
What if you could buy into the same type of portfolio at a discount?
You receive the same interest, but pay less to get it. This translates
into a higher yield on your money. This is a frequent possibility
with closed end income funds whose shares sell at a discount to
the value of the bonds in the portfolio.
When you sell your shares, you do not sell them back to the fund,
but rather, sell to another investor just like when you sell shares
of stock.
These funds can be an excellent source of superior income. Ask
a couple questions to make sure you are not taking extra risk:
What percentage of bonds in the portfolio are premium bonds?
If that number is significant, say more than 20%, this could lead
to erosion in the bond portfolio value as these bonds mature at
par
Does the fund use leverage—does it borrow to buy bonds?
While this strategy can lead to a significant increase in the
interest you earn, leverage cuts both ways and can cut into the
yield if short-term rates rise quickly.
You can find a comprehensive list of closed end income funds
in Barrons, issued every Saturday.
You can find a guide to closed end funds at http://www.ici.org/pdf/guide2closed-end.pdf
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