NEW YORK ( Thestreet ) -- Yield-hungry investors should consider closed-end bond funds.
According to Closed-End Fund Advisors, the average tax-free municipal fund yields more than 6%. That is the equivalent of a taxable bond yielding more than 9% for high-income investors. The closed-end yields are tempting at a time when 10-year Treasuries yield 2.6%.
Make no mistake, closed-ends come with risks. When interest rates rise, all kinds of bond funds tend to fall. Closed-end funds can be especially volatile. But chances are rates will not climb much for at least the next year or two. In the meantime, investors should be able to collect rich yields from closed-end funds without suffering significant capital losses.
Closed-end funds, which hold portfolios of stocks or bonds, issue a fixed number of shares that trade on exchanges like stocks. In bull markets, the shares can command hefty premiums to the value of assets. During hard times, closed-ends shift to discounts. Fixed-income funds currently trade at average discounts of almost 6%. So an investor can get a dollar's worth of assets for 94 cents.
The funds slipped into discounts last year after interest rates rose. The discounts remain wide because investors worry about the impact of increasing rates on the leverage that many closed-ends use. To appreciate the impact of leverage, consider a fund with a portfolio of $100 million in bonds. The portfolio manager borrows $30 million against the assets. The fund pays an interest rate of 1% to borrow the cash and invests the money into bonds that yield 4%. The resulting spread boosts the yield of the fund, but it also comes with risks. If bond prices sink, the leverage could magnify losses.