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By Jason Stipp | 08-24-2010 04:30 PM

A Closer Look at Closed-End Fund Yields

Many closed-end funds offer enticing yields, but investors must do their homework to choose and use these investments wisely.

Jason Stipp: I'm Jason Stipp from Morningstar. We're talking about yield again today, and we're taking a closer look at closed-end funds, and some of the higher yielding closed-end funds--some investments that may have caught the yield seeker's eye recently.

Here with me to talk about who should be thinking about these funds and what to think about as you are selecting a closed-end fund is Morningstar's Cara Scatizzi, she is a closed-end fund analyst, and Morningstar's Christine Benz, she is director of personal finance for Morningstar.com. Thanks so much for joining me.

Cara Scatizzi: Thanks Jason.

Stipp: Cara, first question for you. You've been looking at the closed-end fund space and you are devoted to this. In the current low-yield environment a lot of the closed-end funds look like they do have pretty attractive yields. Obviously, there is more to the story than just that number, but how is that they are yielding more than some other investments in this low-yield environment?

Scatizzi: Sure, the structure of the closed-end fund actually allows it to invest in a lot of high-yielding investments that traditional mutual funds and individual investors can't really do on their own. Things like junk bonds, municipal bonds, senior loan funds, and preferred stock. This is because these tend to be illiquid, they tend to be very volatile, thinly-traded, and because the closed-end fund is closed, it can hold on to these more illiquid securities because it doesn't have to keep money around for shareholder redemptions.

Stipp: So basically the way that these funds work is, investors will buy them on an exchange but they are not sending money to the fund company, and the fund company doesn't having to meet redemptions [either]. So in times when money is moving in and out of funds, they can maybe sit tight and not have to meet those redemptions?

Scatizzi: Exactly.

Stipp: Okay. Christine, some of these areas where the closed-end funds are investing--and I know that we have written about some of the higher-yielding areas where they are investing--these obviously come with some degree of risk above and beyond what you would normally see in an income-investing instrument. How should you think about that as a part of your portfolio plan?

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