Closed-end funds are tricky. these products, which predate more popular exchange-traded funds by 100 years, hold a portfolio of stocks, bonds or both, and trade on exchanges just like stocks and ETFs do. But unlike ETFs, closed-end funds don’t come with a mechanism to keep their share prices near the value of their assets. So a closed-end fund’s price can be much different from its net asset value per share.
Savvy investors seek to capitalize on these anomalies. They buy a closed-end when it trades at a discount to its NAV, then sell when the discount shrinks or the price moves to a premium to NAV.
But why bother with the complexities when you can buy an ETF that does the work for you? PowerShares CEF Income Composite Portfolio (Symbol PCEF) tracks an index of income-oriented closed-end funds. The ETF holds closed-ends that own high-quality bonds and ones that own junk bonds; it also holds funds that sell options against their holdings. The index the ETF tracks favors funds that trade at a deep discount to NAV and underemphasizes those that sell at premiums. “Taking advantage of disconnects between premiums and discounts is at the heart of closed-end fund investing,” says Scott Eldridge, of Invesco PowerShares.
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The result is a product that delivers a terrific 7.4% yield and has traded in a fairly narrow range since its launch five years ago.
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