Closed-end funds (CEFs) are a type of investment vehicle that are potentially appealing for income investors looking for diversification and high yields. CEFs can be useful investment vehicles for income investors due to their unique qualities, such as more predictable income.

The fact that CEFs can sometimes be exploited due to their deviation from NAV makes things all much more exciting if trading decisions are executed correctly (i.e., buying below NAV or selling above NAV).

That said, CEFs come with their own set of risks, including depending on the fund manager’s skills to produce returns, the potential lack of adequate liquidity, and more.

In this article, we will explore what Closed End Funds are, how they work, and why they can be a good investment option for those looking to generate income.

CEFs Overview

Closed-end funds are similar to traditional mutual funds in that they both pool together money from multiple investors and use that money to invest in a diverse portfolio of assets.

However, unlike mutual funds, which can issue and redeem new shares as needed, CEFs have a fixed number of shares that are issued at the time of the fund’s initial public offering (IPO). This means that the price of a CEF’s shares is determined by supply and demand on the stock exchange rather than just the underlying value of the assets in the fund.

CEFs have a fixed number of shares. These shares are traded on a stock exchange, just like ordinary stocks, but the fund itself does not issue new shares or buy back/redeem existing ones in response to investor demand.

As a result, the price of a CEF share can contrast notably from its underlying net asset value (NAV), depending on the supply and demand of its shares in the market.

In contrast, ETFs are designed to track the performance of a particular index or basket of assets. Their prices tend to stay close to their NAV because they are constantly issuing and redeeming shares in response to investor demand.

ETFs are predominantly passively managed as they generally aim to track the performance of an index or benchmark as closely as possible rather than trying to outperform it.

In contrast, CEFs are typically actively managed, which means that fund managers pick the underlying securities and make decisions about when to buy and sell them based on their own research, analysis, and the fund’s targets. For this reason, CEFs often have significantly higher expense ratios than ETFs as well.

Advantage of CEFs: Diversification

One reason CEFs could be ideal investment vehicles for income-oriented investors is that, by nature, they are diversified and provide shareholders with flexibility.

Regarding diversification, the portfolios of CEFs are typically exposed across a wide range of assets, which can help to reduce risk and enhance the stability of the fund’s income stream. As far as providing flexibility goes, CEFs come in a variety of types, such as those focused on income generation, growth, or a combination of the two.

As a result, income-oriented investors could choose between high-yield CEFs, dividend-growth CEFs, or anything else that aligns with their investment goals and risk tolerance. 

Closed End Fund: Cohen & Steers Infrastructure Fund (UTF)

For instance, The Cohen & Steers Infrastructure Fund (UTF), as its name suggests, is focused on investing primarily in infrastructure assets. It holds stocks in companies that own electric transmission networks, toll roads, freight rails, pipelines, and cell towers, among others.

UTF has a trailing 12-month yield of 7.8%.

Closed End Fund: BlackRock Science and Technology Trust (BST)

Another attractive closed end fund for income investors, particularly those looking for capital appreciation, is the BlackRock Science and Technology Trust. BST is a closed ended equity mutual fund launched by BlackRock, that through derivative such as around the world. The fund’s investment objective (as its name implies) is to make investments in the science and technology industries.

Both UTF and BST pay their dividends monthly, rather than quarterly like most stocks. Monthly dividend payments are generally more attractive for income investors looking for more frequent payouts.

BST pays a quarterly dividend of $0.25, for an annualized payout of $3.00 per share. This equates to a current yield above 8% for BST.