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Low Interest Rate Woes? High Yield Closed-End Funds May Be the Cure

NEW YORK (TheStreet) -- High-yield closed end funds such as GAMCO Global Gold & Natural Resources (GGN), Kohlberg Capital (KCAP) and Guggenheim Enhanced Income Equity Fund (GPM) run counter to the paltry returns of the current low interest environment. The average yield for a member of the Standard & Poor's 500 Index (SPY) is around 1.8%. High-yield closed end funds may be attractive not just to those seeking more income.

Closed-end funds are like mutual funds, but with a finite number of shares issued at the initial public offering. As a result, closed-end funds can sell at less than asset value. When a sector is out of favor, the closed end fund can sell at much less than asset value if the price drops.

That discount has an obvious appeal to value investors.

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For growth investors, the allure is just as compelling.

Just as the assets sell for less when a closed-end fund sells at a discount, so is the growth potential discounted in the share price. In addition, it is much more difficult to set an accurate value on the growth ahead for all of the holdings of a closed-end fund. For those buying at a discount, that can result in robust overall returns from market inefficiencies.

I've written before on how closed-end funds can be profitable for savvy growth and value investors willing to perform the necessary research, ready to wait for the right time to buy and then able to hold the shares for the long term.

High-yield closed end funds beckon income investors most of all. The chart below shows the disparity between what these funds offer compared to "Dividend Aristocrats" such as Coca-Cola (KO), Exxon Mobil (XOM), and Wal-Mart (WMT). To become a Dividend Aristocrat, companies like Coca-Cola, ExxonMobil, and Wal-Mart have increased their dividend annually for the last 25 years.

All are industry leaders with a rich dividend history -- but they still offer yields far below leading closed-end funds.

Security

Yield

Coca-Cola common stock

2.90%

Exxon Mobil common stock

2.70%

Wal-Mart common stock

2.50%

Standard & Poor's 500 Index stocks' average yield

1.80%

GAMCO Global Gold & Natural Resources closed-end fund   

10.40%

Kohlberg Capital closed-end fund

12.40%

Guggenheim Enhanced Income Equity closed-end fund

5.30%

Source: Yahoo! Finance

As with the purchase of any asset, thorough due diligence is required before buying closed-end funds. And these funds are not for the short term.

But for savvy and patient investors, these funds can offer high yields. Just like stocks, closed-end funds will fall when the sector is in disfavor. That results in a lower share price with a higher yield. For the long term investor, it does not get much better.

At the time of publication the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff. TheStreet Ratings team rates COCA-COLA CO as a Buy with a ratings score of B+. TheStreet Ratings Team has this to say about their recommendation:

"We rate COCA-COLA CO (KO) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its expanding profit margins, good cash flow from operations, reasonable valuation levels and notable return on equity. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The gross profit margin for COCA-COLA CO is rather high; currently it is at 65.87%. It has increased from the same quarter the previous year. Along with this, the net profit margin of 15.30% is above that of the industry average.
  • Net operating cash flow has significantly increased by 123.01% to $1,066.00 million when compared to the same quarter last year. In addition, COCA-COLA CO has also vastly surpassed the industry average cash flow growth rate of -5.97%.
  • COCA-COLA CO's earnings per share declined by 7.7% in the most recent quarter compared to the same quarter a year ago. The company has suffered a declining pattern of earnings per share over the past year. However, we anticipate this trend reversing over the coming year. During the past fiscal year, COCA-COLA CO reported lower earnings of $1.90 versus $1.96 in the prior year. This year, the market expects an improvement in earnings ($2.10 versus $1.90).
  • KO, with its decline in revenue, slightly underperformed the industry average of 2.9%. Since the same quarter one year prior, revenues slightly dropped by 4.2%. The declining revenue appears to have seeped down to the company's bottom line, decreasing earnings per share.

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