If interest rates are on the rise then closed-end funds (CEFs) that invest in equities should perform better than CEFs that invest in bonds.
"Rising interest rates are a market response to better-than-expected growth-and equities generally rise as earnings and profits expand," said Doug Bond, portfolio manager for the Cohen & Steers Closed-End Opportunity Fund (FOF - Get Report) . "If the reason rates rise is higher-than-expected inflation rather than better growth, then rising rates will put pressure on both equity and fixed-income closed-end funds."
Bond said the market has recently been focusing a lot on the selloff in the 10-year Treasury note. The yield on the 10-year Treasury has jumped to 1.8% at last check from 1.4% in July. Bond said historically, in the one-year period after 10-year yields have risen by 30%, equity CEFs perform better than fixed-income CEFs.
Bond believes the most common mistake made by investors in the CEF selection process is putting too much weight on the current distribution yield or discount to net asset value. "We believe that while yield and discount are a reasonable place to start, there's more work to be done when deciding to invest hard-earned money in closed-end funds," said Bond.
Recently, new issue activity has been pretty quiet, but Bond believes it could get busier if the discount narrowing the market has seen in 2016 persists. "We think the relatively limited new supply has focused most investor attention on opportunities in the secondary market," said Bond.
In terms of where he is finding value, Bond said he is finding more value in equity funds than in fixed-income funds at the moment.
"The recovery we've had in equities since 2009 has been impressive, and yet we feel we're in the midst of the most unloved bull market in stocks in our career. Equity fund discounts are above their long-term average, and unlike fixed-income funds, where discounts moved below their long-term averages earlier this year, equity discounts have remained persistently wide of their long-term average of about 5%," said Bond.
"Just recently we also saw some attractive opportunities among select municipal bond CEFs, which had sold off amid concerns of rising interest rates," added Bond.