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Hot Yields Drive Rebirth of Closed-End Funds

For years, closed-end funds have been overshadowed by their more glamorous cousins, exchange-traded funds. Now they're staging a comeback.

Key to their success is a renewed interest in investments that generate yield as baby boomers approach retirement age. But closed-end fund managers have also had to adapt and overhaul their investment strategies as some of the traditional sources of yield disappeared.

Since November, the record for largest initial public offering for a closed-end fund has been broken three times.

Like ETFs, closed-end funds are traded on an exchange. But unlike ETFs, which are created and dissolved as needed, closed-end funds issue a fixed number of shares. This structure lends itself to investing in illiquid securities and using leverage to juice returns, because managers don't have to worry about raising cash to meet redemptions.

It also has a major drawback: share prices of closed-end funds can move sharply out of line with the value of their holdings, allowing investors to snap them up at a discount or forcing them to pay a premium.

By comparison, investors love ETFs for their low fees and tax advantages. ETFs also tend to closely track the net asset value of their component securities. That's because market makers create new shares when prices move up to a premium over NAV and dissolve them into their constituent securities when prices fall to a discount.
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