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Closed-End Funds Dive in Down Markets

A byproduct of the financial crisis, as has been the case in past crises, is that closed-end funds come unglued. This has happened before, is happening now and, more importantly, will happen again.

The reason for this is the structure of the product. They have a fixed number of shares (save for the occasional secondary offering) and so the market price can deviate from the net asset value of the fund. This creates a discount or premium to the net asset value.

The strategy of buying a closed-end fund that has a wider discount than normal and selling it when the discount narrows or even swings to a premium is somewhat popular and valid, although it is not easy.

Then there are times, like now, where things move violently out of sorts. Below are charts of the discount history of three not-so-randomly chosen closed-end funds. They all show a similar cliff dive very recently. They are not so randomly chosen, because earlier this week, Jeff Saut recommended them to clients at Raymond James.

The funds are BlackRock Strategic Dividend (BDT), BlackRock Enhanced Dividend Achievers (BDJ - Get Report) and Eaton Vance Tax-Advantaged Global Dividend Income (ETG - Get Report). According to Saut, all three have blue-chip portfolios and they pay generous dividends.

Many closed-end funds have blue-chip portfolios and pay generous dividends. The point is not to pick on Saut or the funds he chose but instead to create a better understanding of how the product works. During times of unusual uncertainty or panic, it makes sense to expect closed-end funds to react very negatively.

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