Closed End Bond Funds Open Doors to Higher Income

The stock market today reminds me of what it must be like to marry for money. The numbers are tempting but the tension is terrible. Fear stems from the current four horsemen of the Apocalypse: unemployment, housing, European economic strains and U.S. debt levels. All four of these had their roots in the 2007-2008 financial crisis. All would be aided by a political effort unified toward recovery rather than to pimping for votes.

On the sunnier side of the street, interest rates remain at remarkably low levels, inflation is modest and the economic recovery is still inching ahead despite various resistances. Stocks are showing some signs of breaking out of their month-long slump. Their valuations are reasonable enough to support further gains even though we are probably weeks away from any sustained rebirth of confidence.

The period just ahead will probably thus continue to feature unsettling swings in the market. It should be quite rewarding for coolheaded investors who ignore the screaming ninnies on television and pick up higher yielding blue chip stocks while they are on sale.

For those who don’t own Apple (AAPL-$385), this is your time. No dividend there but rising dividends come with McDonald’s (MCD-$90), Chevron (CVX-$98) Bristol-Myers (BMY-$29) and DuPont (DD-$47). IBM (IBM-$172) and Accenture (ACN-$53) offer 2% initial yields and robust sales. Annaly (NLY-$18) is paying over 12% from leveraged mortgage investments, a good investment with today’s low short-term rates.

Today’s investment climate of low rates and high anxieties is excellent for many closed end funds. These differ from more widely known “mutual funds” in that closed end funds employ fixed capital amounts rather than depending on their sales forces to induce additional purchases. Their advantage is that they avoid the timing problems of mutual fund managers brought on by their investors’ practice of adding funds near market tops and withdrawing near market lows.

Their disadvantage is that they trade at market prices that vary from their net asset value, often at a discount. This is fine for buyers, who can get a small slice of a pool of securities at a discount, but who must remember that the discount will probably still be around when the holder considers selling. They are thus unsuitable for in and out trading, as are all sensible investments.

During the financial crisis, discounts widened to over 20% as leveraged “investors” were forced to sell anything they could. Despite recent market swings, a solid bond fund like Western Asset Global Corporate (GDO-$18) is trading at a 6% discount and yielding 8.5% in monthly dividends. Similar bond funds we hold include Alliance Global High Income (AWF-$14), Credit Suisse Income (CIK-$3), Wells Fargo Multi (ERC-$15), Franklin Trust (FT-$6), Franklin Limited Term (FTF-$13) and Nuveen Multi-Currency (JGT-$14).

All these are particularly useful for non-taxable retirement accounts. Nuveen CA (NCO-$13) offers a 7% yield in monthly tax-free distributions for taxable accounts. Nuveen, a respected provider of municipal securities, maintains a useful web site at that summarizes closed end funds.

The creative marketing minds of Wall Street invent funds, particularly mutual funds and the newly popular Exchange Traded Funds, to meet every conceivable new whim of investor interest. Closed end funds escape much of the associated hype as they are not subject to remarketing efforts but a useful variety still exists.

One old favorite, Clarion Global Real Estate (IGR-$7) invests in global Real Estate Investment Trusts. As the prices of these REIT’s already reflect their well-known problems and IGR is trading at a 12% discount, this double markdown produces a 7.5% yield with prospects of capital gain.

Finally, two new funds use option strategies in connection with portfolios of blue chip stocks with high current income as the primary objective. ING Emerging Market Dividend (IHD-$15) and EV Enhanced Equity Income (EOI-$10) are beginning operations with 10% discounts and 10% yields. These will vary but their newness combined with current investor skepticism indicates that they are very favorably priced at this time.

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