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By Jeremy Glaser | 06-10-2010 11:04 AM

Risk in Closed-End Fund 'Yields'

Morningstar's Mike Taggart warns investors that not all distributions from closed-end funds are created equal.

Jeremy Glaser: Risk in closed-end funds. I'm Jeremy Glaser with Morningstar.com. As investor interest in closed-end funds increases, as people search for more yield, is everyone aware of the risks involved?

I am here with closed-end fund Strategist Mike Taggart to take a look at some of these risks. Mike, thanks for talking with me today.

Mike Taggart: Yeah. Thanks for having me down.

Glaser: So, one thing that people have been really interested in is the yield that comes in closed-end funds, with getting basically 0% everywhere else, these yields look really attractive. So anything investors should know about that number?

Taggart: Yeah, there are couple of things, Jeremy, when it comes to closed-end funds and yield. First of all, most investors in closed-end funds are income-oriented investors.

So there's two things I'd like to point out; first of all the payout that investors receive from closed-end funds, most investors are used to calling them yield, they are used to calling them dividends, but they are actually neither of those, they are distribution rates. And there's three categories, there are three places where this—the things that compose distribution can some from. They can come from income in dividends, they income from realized capital gains or they can come from something that's called return of capital.

So I've written an article on this, but let me just try to make it very simple for the video. If you give me four quarters, $1 and I give you $0.25 of that back, that's not a yield, okay? That's a return of capital. And a lot of times funds will do this and they'll return some of the capital to people, it bumps up the published, what people call, yield and then they want what they—investors will flock into these funds, not realizing that they are getting actually a return of capital.

So, there are three things I think in terms of the payout; the investor should keep in mind to make sure that the yield or the distribution rate that they are getting is sustainable.

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