Exchange-traded funds, or ETFs, are popular these days, but closed-end funds, or CEFs, can be a great option for investors seeking income as well.
Like stocks, CEFs debut via an initial public offering, or IPO, where the fund manager issues a fixed quantity of shares. These shares can track a variety of underlying assets, including equities, fixed income, commodities and even cryptocurrencies. Once issued, the shares then trade on the secondary market between individual investors.
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However, unlike ETFs, CEFs will not accept additional inflows of capital or issue new shares after the IPO. Therefore, depending on supply and demand, the share price of a CEF can diverge from its net asset value, or NAV, and trade at a premium or a discount.
Like ETFs, CEFs also make periodic distributions, which can consist of dividends, ordinary income, capital gains and return of capital.
“The recent confluence of inflation, bank failures and rising interest rates have introduced a level of volatility into the stock and bond markets that has left investors scrambling for stability,” says Angelo DeCandia, business instructor at Touro University.
Stability often translates to income for investors who recognize that a dollar in your pocket may be worth two in the volatile stock market, and CEFs can be a great source of income.
“Closed-end funds have been around for over a century, but the recent interest may be credited to their ability to sometimes deliver excess income and returns without the risk of alternative investments,” DeCandia says.
That’s not to say closed-end funds don’t come with risks. These funds often use derivative strategies and leverage to enhance returns. The fact that closed-end funds trade like stocks with the share price a function of supply and demand rather than net asset value could also expose investors to the risk of not being able to find a willing buyer or having to sell at a discount when they want to sell.
With that in mind, here are four of the best closed-end funds for income in 2023, according to industry experts:
| Closed-end fund | Distribution rate |
| Eaton Vance Tax-Managed Diversified Equity Income Fund (ticker: ETY) | 8.39% |
| Thornburg Income Builder Opportunities Trust (TBLD) | 8% |
| John Hancock Tax-Advantaged Dividend Income Fund (HTD) | 7.56% |
| Cornerstone Total Return Fund (CRF) | 19% |
Eaton Vance Tax-Managed Diversified Equity Income Fund (ETY)
Daniel Milan, managing partner and investment advisor representative at Cornerstone Financial Services in Southfield, Michigan, considers ETY to historically be “one of the best performing closed-end funds with strong management and great tax-advantaged income.”
The fund uses a covered call equity strategy on indexes that approximate the fund’s holdings. This means that it will sell call options, or the right to buy shares, on an index like the S&P 500. Since you can’t own an index, however, these options are cash-settled, meaning they pay out cash at expiration, rather than the underlying security and the “loser” pays the “winner” the difference.
The fund gets the additional income from the premiums on sale of the calls while taking on minimal additional risk since it holds similar securities to the index. So, if the index rises and the purchaser of the call option exercises his right for cash settlement, the manager can compensate for the cost with an appreciated portfolio.
ETY pays monthly distributions and has an impressive total distribution of 8.39%. It pulls this off with a dividend capture strategy. This entails selling a stock on or shortly after the ex-dividend date — which means the fund gets to keep the next payable dividend — then using the proceeds to buy other stocks that are expected to pay a dividend before the stock that was sold.
The cherry on top of this sweet sundae is that ETY provides all of this while minimizing federal taxes. Strategies include seeking stocks with dividends that qualify for more favorable long-term capital gains rates and using tax-loss harvesting, or selling some assets at a loss to offset gains on other assets sold for a profit during the year.
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Thornburg Income Builder Opportunities Trust (TBLD)
Similar to ETY, TBLD seeks current income and total return by investing in global securities alongside covered call options. Unlike ETY, however, TBLD will also write (or sell) uncovered call and put options. This could increase the level of risk in the fund as uncovered options may require management to purchase additional shares to satisfy exercised options. That said, less than 12% of the portfolio is currently leveraged, which is on the low end of the allowable 10% to 40% defined in the investment objective.
TBLD also aims to enhance income by investing in fixed-income securities in addition to equities. The portfolio is currently about one-third fixed income and 65% equity, with the remainder of assets in cash-like securities.
The 8% total distribution is “an attractive return for most investors, especially since it is achieved with little leverage,” DeCandia says. The fact that the fund is currently trading at just under an 11% discount compared to a 12.62% six-month average discount on the price suggests “investors are currently showing slightly greater confidence in the fund’s direction,” he adds.
John Hancock Tax-Advantaged Dividend Income Fund (HTD)
Another option for investors seeking tax-sensitive equity income is the John Hancock Tax-Advantaged Dividend Income Fund. Like ETY, it looks for dividend-paying securities that qualify for long-term capital gains tax rates rather than the higher ordinary income rates applied to nonqualified dividends.
HTD invests at least 80% of its assets in dividend-paying stocks and preferred securities across many sectors with an emphasis on utilities — which currently account for about 60% of the portfolio as of March 31 — as this tends to be a high dividend-paying sector.
“With a distribution rate of 7.56% of share price, this fund provides a healthy return for most investors,” DeCandia says. However, you “should take note of a 35% total leverage ratio, a possible risk down the road.” This means that for every dollar of investable capital in the fund, $0.35 comes from leverage.
Cornerstone Total Return Fund (CRF)
“For those investors who are willing to boost their income distribution with capital appreciation, this fund may be worth a look,” DeCandia says.
CRF may also invest in other closed-end funds, although it caps such investments so that CRF never owns more than 3% of the voting shares of any one investment company.
As of April 11, it was trading at a 14.18% premium to net asset value. “Admittedly a fairly high premium, CRF may currently present a buying opportunity as its six-month average premium has been even higher at 18.66%,” DeCandia says. The current price of $7.41 is also on the lower end of its 52-week range.
And a premium may be worth paying when you get a look at the current total distribution rate of 19% — more than double the other names on this list.
“On a bright note, the fund achieves this return with a relatively small leverage ratio of 9.5%,” DeCandia says. “Returns this high do not come risk-free, and some investors may decide that CRF is worth the risk.”
If you like funds with long histories, this may also be the closed-end income fund for you, as it recently celebrated its 50th birthday.
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4 Best Closed-End Funds for 2023 originally appeared on usnews.com
Update 04/17/23: This story was previously published at an earlier date and has been updated with new information.
