Closed-End Fund Types and Strategies
Closed-end funds offer regular distributions based on a wide variety of asset strategies. Because of their unique structure featuring minimal cash in or out of the fund, closed-end funds may allow retail investors access to assets and strategies that might not typically be available via other retail investment products.
This site groups closed-end fund strategies into four main categories:
- Tax-free income funds, also known as municipal bond strategies
- Taxable income funds
- US equity funds
- Non-US equity and income funds
Tax-Free Income Strategies
Tax-free* income strategies invest mainly in municipal bonds. Municipal bonds are debt issued by a state, city, or other municipality for general governmental needs or to finance special public projects. Municipal bonds pay interest that is free from regular federal income tax, and state-specific bonds can provide residents of those states with income free from state and, in some cases, local income taxes as well.*
Municipal bonds can be an advantageous alternative to taxable investments, particularly for investors in higher tax brackets. To make a fair comparison between a tax-free investment like a municipal bond and a taxable investment, one should adjust the tax-free investment's yield to account for money saved in regular federal, and sometimes state, income tax.
Municipal bond funds represent the largest single category in the closed-end fund market, offering many national municipal bond funds and several state-specific funds.
* Interest on out-of-state bonds and dividends paid by national funds may be subject to state and local taxes. Income may also be subject to the Alternative Minimum Tax.
Taxable Income Strategies
Taxable income strategies include taxable corporate and government bond funds, convertible bond funds, preferred securities funds, and senior loan funds. These strategies invest in income-generating securities that may offer high potential yields, diversification potential, or both for income-oriented investors. These funds offer credit profiles ranging from US government guaranteed to investment grade to high yield or unrated debt, as well as various maturity ranges. They also offer exposure to various portions of the issuer’s capital structure, ranging from senior secured loans down to unsecured junior debt to preferred securities and preferred stock.
- Government bonds, bills, and notes are backed by the full faith and credit of the U.S. government, and feature maturities ranging from 90 days to 30 years.
- Agency bonds, while not backed by the US Government, are issued by US government agencies, rather than the Treasury, and also have varying maturities.
- Corporate bonds are issued by corporations to finance ongoing business activities, and typically carry ratings from one or more nationally recognized ratings agency. High yield bonds have lower credit ratings or are unrated. Lower ratings indicate the bonds may be subject to a greater risk of default than investment-grade securities.
- Convertible bonds offer the opportunity to convert a bond into the issuer’s stock, giving the investor higher appreciation potential if that stock value increases, but with potentially lower coupon payments when compared to non-convertible bonds with similar credit and maturity features. In some market environments, convertible bonds carry potential risks and advantages similar to bonds, and in other environments their risks and benefits are more similar to equities.
- Preferred securities are usually junior liabilities of an issuer, pay fixed or adjustable rate dividends, have a "preference" over common stock in the payment of dividends and the liquidation of a company's assets, and often are issued for a finite term. They are not bonds but often have bond-like characteristics like credit ratings and call features. Because they are below bonds in the issuer’s capital structure, they have historically paid higher yields than bonds from the same issuer, while carrying higher risk in the event of that issuer’s default.
- Senior loans are commercial loans, senior to other loans and debt in a company's capital structure. Floating rate senior loans have an interest rate that resets periodically, are usually secured by specific collateral, and are often rated below investment grade. Like high yield bonds, this means they are subject to a greater risk of default than investment-grade securities. However, in the event of liquidation, investors in these types of loans are given the highest priority for repayment – before holders of preferred and common stock and subordinated bondholders.
All fixed income bonds carry credit risk and interest rate risk. As interest rates rise, fixed income prices will fall.
US Equity Funds
Within the larger group of US equity funds are categories including general equities, dividend-oriented stocks, tax-advantaged stock investments, specific sectors of the stock market, covered call strategies, REITs (Real Estate Investment Trusts), and MLP funds (Master Limited Partnerships).
Equities, or stocks, basically represent a share of ownership in a company. The value of that share can rise and fall based a whole host of factors – the company's performance, market conditions and more. However, the equity markets can also experience periods of extreme volatility.
- Growth stocks are issued by companies that have exhibited faster than average growth or gains.
- A value stock is one that investors believe may be trading at prices below its perceived market value.
- Large-capitalization stocks represent the biggest companies.
- Small-cap stocks are from companies with smaller market capitalization.
- Domestic stocks represent U.S. companies; international or global stocks represent companies from other countries.
Many investors buy stocks because, historically, as a group they have shown the highest returns.
Covered call strategy funds invest in portfolios of stocks and also sell call options on either individual stocks or stock indices. Some funds may also purchase put options to try to protect the portfolio from extreme drops in the stock market. Potential return from these funds comes from stock dividends, premiums received from selling call options, and stock appreciation (or depreciation).
A Real Estate Investment Trust (REIT) is a publicly-traded company that owns, and usually operates, income-producing commercial real estate, such as apartments, shopping centers, offices, hotels and warehouses. REITs and funds that invest in them typically are designed to provide attractive, growing dividends based on rents or income received from the underlying commercial real estate investments. REIT performance is linked to the performance of the commercial real estate market. Property values and rents may fall due to economic, legal, or cultural developments.
Master Limited Partnerships (MLPs) are publicly traded partnerships or limited liability company, and usually represent ownership in energy production or energy infrastructure. MLPs are tax-advantaged investments offering attractive cash flow potential, and thus subject to the risk of changing tax policies, as well as risks related to concentrated ownership in the energy sector.
Global and international funds invest in equities and debt securities issued by a broad range of companies and governments, and can be diversified across countries, regions, economic conditions and credit ratings.
Global equity funds invest in specific countries or regions, or may invest in certain types of stocks, such as dividend-oriented stocks, from across the world. Global debt funds offer income-oriented investors exposure to debt issued by other countries' governments (this is known as "sovereign debt") or by global corporations. Some funds also offer income or total return based on actively investing in securities linked to the currencies of various countries, seeking to benefit from the relative strength or weakness of one currency vs. another.
Some fixed-income securities are rated for credit worthiness and payment default risk by independent ratings services such as Standard & Poors and Moody's Investors Service. Sometimes a fund can gain exposure to the returns of global debt investments more efficiently by investing in derivative securities instead of directly buying non-U.S. bonds.
In addition to the risks linked to stocks or bonds in general, non-US funds also carry additional risks based on their exposure to corporations or countries that may have different accounting, legal, and communications environments, less liquid markets, as well as unanticipated economic, political, or social developments in those countries. However, this exposure to non-US investments often offers additional diversification and/or return potential for shareholders of the funds that invest in them.