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Closed-End Funds Beat ETFs, Mutual Funds

Morningstar's Taggart notes that some closed-ends suffered huge losses during the financial crisis. But he says that investors who had the stomachs to hold through the rough times were rewarded as the markets rebounded.

Should you consider closed-ends now? Perhaps. If you believe that the Federal Reserve will keep its pledge to hold down interest rates into 2014, then closed-ends are worth considering. In an environment where rates stay flat -- or rise just a bit -- leverage should remain profitable, and closed-ends should continue outdoing mutual funds and ETFs. But keep in mind that if rates spike, the cost of leverage would climb and hurt closed-end returns.

To find funds that can thrive in a period of low rates, look for closed-ends with strong long-term performance records and substantial leverage. A solid choice is Aberdeen Asia-Pacific Income (FAX), which invests in bonds from Australia and such Asian countries as Korea and Indonesia. The fund yields 5.4%. During the past five years, Aberdeen has returned 12.2% annually, outdoing 70% of global bond funds. Most of the fund's assets are invested in investment-grade government bonds. Aberdeen has 16% of assets in bonds that are rated below-investment grade. Those give higher yields, but come with extra risk.

Stock investors can consider Gabelli Equity Trust (GAB). During the past ten years, the closed-end fund has returned 10.4% annually, outpacing the S&P 500 by 2 percentage points. Veteran portfolio manager Mario Gabelli has long been known for his distinctive style of value investing. Gabelli favors companies with solid balance sheets that sell for less than what private investors would pay to acquire the entire businesses. The fund currently has a big stake in industrials. Holdings include farm equipment giant Deere (DE - Get Report) and machinery maker Honeywell (HON - Get Report).

At the time of publication the author had no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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DE $81.64 0.54%
FAX $4.92 0.51%
GAB $5.45 -0.18%
HON $113.69 0.06%
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