This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Closed-End Funds Beat ETFs, Mutual Funds

Stocks in this article: FAX GAB DE HON

NEW YORK ( TheStreet ) -- Since the financial crisis, most mutual funds have delivered solid returns. But investors could have done even better with closed-end funds. During the three years ending in 2012, the average intermediate-term bond mutual fund returned 7.0% annually, compared to a return of 11.4% for closed-end peers, according to a Morningstar study. While emerging-markets mutual funds returned 4.3% annually, closed-end returned 6.7%. Most closed-end funds also topped comparable ETFs. The average foreign large value closed-end returned 5.7%, compared to 3.2% for comparable ETFs.

Morningstar analyst Mike Taggart says that the peculiar structure of closed-end funds has enabled them to get a big boost from the low interest rates of recent years. Like mutual funds, closed-end funds hold portfolios of stocks or bonds. But closed-end funds issue a limited number of shares that trade on stock exchanges. In contrast, traditional mutual funds can sell an unlimited number of shares.

Closed-end funds have gained an important edge because they can use leverage. In a typical deal, a fund starts by raising cash from investors. After investing the money in bonds or stocks, the closed-end portfolio manager can then borrow against the assets, taking a bank loan or issuing preferred shares. Using the proceeds of the borrowing, the manager buys more bonds or stocks. Many closed-end funds have leverage ratios of around 30%. So a fund that raised $100 million from investors would use borrowings to buy an additional $30 million in assets.

In the current low-rate environment, leverage is extremely profitable. A portfolio manager can pay 1% for a short-term loan -- and then use the cash to buy bonds that yield 4%. The extra income from the leveraged purchases boosts the fund's yield and total return. Regulators limit the ability of mutual funds to use leverage.

Make no mistake, leverage can be risky. Just as it can magnify gains in a bull market, leverage can exaggerate losses in a downturn. If interest rates spike, then closed-end bond funds could crater. Even in flat markets, leverage can make funds volatile.

1 of 2

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 17,804.80 +26.65 0.15%
S&P 500 2,070.65 +9.42 0.46%
NASDAQ 4,765.38 +16.9840 0.36%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs