Municipal Bond Forum
Closed-end bond funds
Q
Why would an individual not invest in leveraged closed-end bond funds and pick up an additional 50 to 100 basis points of yield rather than buying individual bonds as well as professional bond management?
A
James A. Klotz responds:
There are a number of reasons why an investor might want to avoid closed-end funds. First, you need to be aware that the yield being quoted on the fund is not equivalent to the “yield to maturity” of an individual bond. Since the fund has no maturity date, it is quoted in “current yield,” which reflects the “cash on cash” return of the fund. The lack of a maturity date also eliminates the bonds’ promise to return the full face value of your investment.
If you research closed-end funds, you will find that the majority of them trade below their net asset value (the intrinsic value of the bonds held in the fund). This is the result of the leverage you mentioned – the lower the price goes, the higher the quoted yield.
There are also ongoing management fees, which are not applicable when you own the individual bonds. Although we like to see investors receive some professional help when building their portfolio, we see no benefit for investors to have an actively managed tax- free bond portfolio.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.