BOSTON (TheStreet) -- The stock-market slump has led some investors to turn more defensive, and they are now clamoring for the safety of securities with high yields.
That means bond funds, Dow stocks and REITs. But they may be overlooking closed-end funds such as the BlackRock Credit Allocation Income Trust (BTZ), which offer discounts of 10% or more and generous yields that may produce positive returns this year.
Picking a closed-end fund with an outsized yield trading at a discount to its net asset value (the perceived value of its underlying investments) can seem like finding a needle in a haystack. With diligence and research, they can be found, says Patrick Galley of RIverNorth Capital, a Chicago-based firm with nearly half of its $1 billion in assets invested in closed-end funds.
"A lot of closed-end funds are priced richly based on investors clamoring for that yield," Galley says. "That means a lot of high-yielding closed-end funds are trading at a premium to their net asset value. The deals can be found, but you definitely have to do more digging and more due diligence."Unlike their open-end mutual-fund counterparts, closed-ends funds do not create new shares for investors to purchase. Instead, buyers need to acquire shares from existing holders. RiverNorth has become a go-to shop for investors looking at closed-end funds. RiverNorth's flagship fund, the RiverNorth Core Opportunities Fund (RNCOX) is a Morningstar 5-star open-end mutual fund that is the only so-called "fund of closed-end funds," meaning it is one mutual fund that owns closed-end funds for its holdings. Given the low-yielding environment in the market, thanks to accommodative actions by the Federal Reserve, closed-end funds have become an ideal investment vehicle for investors to enhance income, Galley says. But investors should err on the side of caution and review the discount or premium. That requires investors to conduct due diligence when chasing yields. "Investors are going for yield, and they're not looking under the cover," Galley says. "Where is that yield coming from? Is it from risky assets or a return of capital? They're investing, unfortunately, for the yield and not for the prospects of total return." There's a price to be paid for high yields, as the rule of risk-and-reward still applies. Galley singles out bank loan funds, which are floating-based securities that trade at a premium to their net asset values. Those funds look attractive to investors because of the floating rate, allowing owners to clip a 6% coupon that will increase as interest rates rise.
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