For many investors and potential investors, closed-end funds (CEFs) are shrouded in mystery.

You may have heard of them at some point, but do you know exactly what they are, or how to invest in them? Fundamentally, CEFs represent one of four main types of mutual funds, with the other three being open-end funds, exchange traded funds and unit investment trusts. Of the three, open-end funds are by far the most common in the United States, with significantly greater assets under management than the other fund types combined.

Closed-end funds have their place, however, and can offer great buying opportunities for the savvy investor. According to the Closed-End Fund Association, CEFs have been available since 1893, which is more than 30 years prior to the formation of the first open-end fund in the United States.

CEFs issue shares to the public through an initial public offering (IPO). These shares are then listed on a stock exchange. Investors may sell their shares to another investor in the market, but not back to the fund. This is a fundamental difference compared to open-end funds, which buy back or sell their shares on a daily basis at the net asset value (NAV) computed that day, based on the prices of securities owned by the fund.

There has been little issuance of CEFs over the past few years, a trend that could continue well into the future.

The closed-end fund market can essentially be divided into two categories: stocks and bonds. In general, equity CEFs are fairly valued based on their average discount compared to the past 20 years. Bond CEFs, on the other hand, we believe are certainly attractive in today's market environment. Some of these funds utilize leverage, which means their borrowing costs are on the rise due to increasing short-term rates. As a result, some dividend cuts have occurred, creating not only fear in the market but also wider attractive discounts.

Where to Find Opportunity Now

Specifically, I'd recommend investors take a close look at three CEFs, each of which offers a significant investment opportunity when looking to enter the space.

The Allianz NFJ Dividend Interest & Premium Strategy Fund (NFJ)

The CEF primarily holds equities and some convertible bonds, while also selling call options to generate income. It's currently trading at a discount of 11.2% and yielding 7%. Interestingly, the average discount on this fund over the past five years has been 8.4% and it traded at zero discount as recently as 2014. Meanwhile, other covered call funds are now trading at an average discount of about 1%.

NFJ is very attractive for the sector, and I think it represents a good value for investors who are seeking equity that may behave more defensively in a soft market, in our opinion.

The Voya Prime Rate Trust (PPR)

It's a floating-rate loan fund that has offered an increased dividend over the past few months, partly because it includes assets based on the London Interbank Offered Rate (LIBOR). PPR currently yields 5.6% and trades at a discount of 10.4%, while its 5-year average discount stands at 7%. This fund is interesting because it's distribution should continue to increase in a rising-rate environment.

The Eaton Vance Limited Duration Income Fund (EVV)

The CEF covers multiple sectors and offers the benefit of less interest-rate risk due to the shorter duration. EVV holds a combination of U.S. government bonds, floating-rate loans, and high-yield bonds. It currently yields 6.4% and offers a discount of 13.6%, after trading at a 7% discount as recently as October.

Even if you expect rates to modestly rise in the future, I believe the discount on this fund is disproportionately steep compared to the risk associated with it.

Overall, there are a number of opportunities in the CEF market, but it's important to research which funds are utilizing leverage and how their assets are invested.

One great resource is CEFConnect.com, which offers a list of all closed-end funds in the market and tools for investors to perform their due diligence. It's free, easy to use, and provides extensive information including asset allocations, as well as current and previous discounts.

As with any investment, it also helps to consult an expert on the matter in order to ensure your research is in line with your unique investment goals. With resources like these, and the proper background knowledge, you'll be well equipped to shed some light on the mysterious world of closed-end funds.

By: Maury Fertig 

Fertig is the Co-Founder and Chief Investment Officer of Relative Value Partners in Northbrook, IL. Today, the firm manages over $1 billion in assets and brings an institutional investment methodology to individuals, family offices and small institutions. 

Relative Value Partners' clients and principals hold positions in the funds mentioned above.

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