Earlier this month, I wrote that tax-free closed-end bond funds were ripe for the picking, and this is still the case today. In my income-driven newsletter Peak Income, we currently have three open recommendations yielding a fat, tax-free 6%.
But, as nice as tax-free income can be, the world of closed-end funds (“CEFs”) is much wider. There are CEFs that invest in taxable bonds… stocks… REITs… commodities… There are even CEFs that do nothing but invest in other CEFs.
So today, we’re going to take a look at some of these different fund types, and examine their pricing after the post-Trump bond yield spike. I covered muni funds in my last article, so let’s start with their taxable cousins.
That 90-Cent Dollar: Investment-Grade Taxable Bond Funds
The taxable bond fund space tends to be one of the largest and most actively traded, and there are good reasons for that. Because CEFs juice their returns with borrowed money, it makes sense to use lower-volatility investments like bonds. When the investments in question don’t fluctuate in value all that much, you can more safely add juice to the portfolio via leverage.
Bonds are also fairly illiquid and don’t trade all that regularly. So, by putting a portfolio of bonds into a CEF, you effectively convert illiquid assets into something that’s a lot easier and cheaper to buy and sell.
Taxable bond ETFs generally trade at a slight discount to NAV, but at times those discounts can get extremely wide, which is generally the best time to buy them. This is the time when you can get that elusive 90-cent dollar.
Right now, you can take your pick of investment-grade bond CEFs trading at discounts to NAV of 8%-10%, or even more, and sporting dividend yields well in excess of 6%.
In this bond market, that’s not half bad.
Fed Proof: Loan Funds
You’re probably aware of how the mortgage market works. The bank that made your mortgage loan probably didn’t hang onto it. It’s far more likely that they sold it to Fannie Mae or to some other institutional investor who, in turn, lumped it together with thousands of other loans and turned it into an investment product.
Bank loans often work the same way. Corporate loans are less standardized and harder to package as investments than mortgages, but it can be done. And there are CEFs that specialize in this field. I recommended one to my Peak Income readers this month and another to my Boom & Bust readers, and both are performing even better than expected!
And why might that be? I’ll give you a one-word answer: the Fed!
Bank loans generally have floating rates, so they’re considered to be “Fed proof.” An aggressive Fed means a higher payout, so these funds have avoided the beating that most of the rest of the income world has taken.
All the same, there are still bargains out there. You can put together a portfolio of loan CEFs trading at modest discounts to NAV and yielding 6% or more. Again, that’s not bad in this market.
Fantastic Bargains: Equity Funds
There are also plenty of stock CEFs to choose from, though these can look a lot different than the traditional stock mutual funds you’re accustomed to. Because CEFs tend to be income focused – and because they employ leverage – equity CEFs are inclined to concentrate in utilities, telecom and other low-volatility, high-yield sectors. But there are also specialty equity CEFs that focus on specific corners of the market, and that’s what get me excited.
Right now, Peak Income has two open recommendations in REIT funds and two more in MLP funds.
Real estate stocks have gotten absolutely hammered since the presidential election. REITs have come to be seen as a bond substitute, so rising bond yields (and falling bond prices) means rising REIT yields (and falling REIT prices). And this has created some fantastic bargains for us.
As an example, one of our REIT CEFs is trading at a 12% discount to its NAV… and the NAV itself has been depressed by the selloff in REITs. So, we have a fund trading at a deep discount to an already deeply discounted sector… and it’s yielding over 8% to boot.
MLP funds are also looking good right now, particularly because of the tax issues that can come with owning individual MLPs. Rather than the standard brokerage account 1099, unitholders of MLPs get a separate K1 tax form for every MLP they own… plus they can’t hold the MLPs in an IRA account without risking major tax complications.
But owning MLPs via a CEF eliminates these problems and allows for stress-free IRA ownership. Because of this, MLP CEFs often trade at a premium to NAV rather than the discount that you see in most of the rest of the CEF world. Yet today, many MLP CEFs actually trade at deep discounts, as investors dumped the sector a year ago and have yet to fully return.
To give a perfect example, one of my favorites MLPs – which happens to be a Peak Income holding – is currently trading at a 12% discount to NAV and is yielding 9.4%. And if that doesn’t pique your interest, then I’ll leave you with this to think on…
Do you expect the stock market, as elevated as it is, to return anything close to these numbers long-term?
I didn’t think so.