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By Jeremy Glaser and Cara Esser, CFA | 07-09-2013 04:00 PM

Rising-Rate Fears Create CEF Bargains

As investors ditched certain income-producing assets on worries of rising rates, an abundance of fixed-income CEFs moved into undervalued territory, according to Morningstar's Cara Esser.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Has the recent sell-off in closed-end funds created any values? I'm here today with Cara Esser, a fund analyst here at Morningstar to answer that question. Cara, thanks for joining me.

Cara Esser: Thanks for having me.

Glaser: Let's talk about what's precipitated the sell-off in the closed-end funds space. Why are investors fleeing closed-end funds right now?

Esser: We're seeing this particularly happening in the fixed-income space and that has largely to do with the Fed's announcement in May about the potential rise in interest rates. The interest rates did actually rise a little bit, and as any other bond-type investment, the net asset value will fall as interest rates rise. We are seeing that, but then you are also seeing people just getting scared. A lot of these closed-end funds had bid up the prices to quite large premiums. Investors are getting nervous about rising interest rates and what it will do to the underlying portfolio, so they are just fleeing.

Glaser: With closed-end funds, you're obviously not worried about managers having to potentially sell positions, to meet those outflows, but what impact do investors not being interested in those kinds of funds anymore have on this space? Has it created a lot of opportunity?

Esser: Yes, and that's a big advantage of a closed-end fund. The underlying portfolio doesn't have to be sold off en masse as people leave like you do with a mutual fund. The only thing that's really happening is that the share prices are falling faster than the underlying net asset values are falling. Therefore, you're seeing a lot of funds selling at better valuations. There are larger discounts or much smaller premiums than we've seen in quite some time particularly since a lot of these premiums had been bid up as people were searching high and low for income anywhere.

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