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Why Closed-End Bond Funds Have Delivered Fat Returns

Stocks in this article: EFTNHSTSITEICHY

NEW YORK ( TheStreet) -- For investors seeking to diversify their fixed-income portfolios, the Eaton Vance Floating Rate (EVBLX) mutual fund makes a solid choice.

During the past five years, the mutual fund returned 3.3% annually and outdid 67% of its peers in the bank loan category, according to Morningstar.

But investors could have gotten even better results with the Eaton Vance Floating-Rate Income Trust (EFT), a closed-end fund that returned 5.2% annually.

The Eaton Vance closed-end fund is hardly alone in delivering strong results. In recent years, many closed-end bond funds have outdone traditional mutual funds by wide margins. During the past five years, closed-end intermediate-term bond funds returned 9.8% annually, compared to 6.5% for traditional mutual funds in the same category. Closed-end world bond funds returned 7.6% annually, while mutual funds in the category gained 6.2%.

Top closed-end performers include Neuberger Berman High Yield Strategies (NHS), which returned 13.7% annually, and TCW Strategic Income (TSI), a multisector bond fund that returned 17.4%.

Part of the reason for the outperformance can be traced to the decline in interest rates, which has given a special boost to many closed-end funds. If rates rise, closed-end funds could be hurt. But at a time when the Federal Reserve is committed to keeping rates at rock-bottom levels, closed-ends can be intriguing holdings with rich yields.

Closed-end funds issue a fixed number of shares that trade on exchanges like stocks. Depending on market conditions, the shares can sell at premiums or discounts to the value of the assets in the fund. That is very different from the better-known open-ended mutual funds, which issue an unlimited number of shares and always trade for the value of their assets.

Many closed-end funds are designed to deliver extra yield. Brokers who sell the funds tend to focus on retirees and other income-oriented investors. To provide income, some funds buy high-yielding investments or use leverage.

To appreciate how leverage works, consider the Eaton Vance fund. To boost results, the fund borrowed money and used the cash to buy more floating-rate securities. The closed-end fund has $917 million in total assets. Of that, about $330 million was purchased with borrowings.

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