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Closed-End Funds Offer High Dividends

As of last week, Engex Incorporated’s shares had soared 170% so far this year. Engex is not a conventional corporation; it’s a closed-end mutual fund. In fact, Engex is only one of 298 closed-end funds that have chalked up 50% or higher year-to-date returns. 

Closed-end funds are similar to conventional (open-end) mutual funds in that they invest in dozens of stocks or bonds, affording investors the advantages of diversification plus professional management. However, in most other respects, closed-end funds operate differently than open-end funds.

When you buy a conventional fund, you purchase your shares from the fund itself, rather than from another investor. The price you pay is the value of the fund’s holdings (assets), expressed on a per-share basis (net asset value). It doesn’t matter whether more investors want to buy than sell, or vice versa.

When more investors are buying than selling fund shares, the conventional fund manager must find places to invest the new money. Conversely, when sellers outnumber buyers, the manager must sell existing holdings to raise cash to redeem the shares.

About Closed-End Funds
A closed-end fund sells a fixed number of shares via an initial public offering (IPO). After that, the fund doesn't buy or sell shares. The shares trade on the open market just like stocks. The share prices depend on the supply and demand. They rarely trade exactly at the net asset value. Instead, they either trade at a premium (above) or at a discount (below) to their net asset value (NAV).

Closed-end fund managers can implement long-term investment strategies without worrying about raising cash to redeem shares, or finding places to invest unexpected new cash.

This stability seems to lend itself particularly well to funds that focus on paying high dividends to shareholders. That’s the category that I find of most interest.

Screen For Ideas 
A new website, CEF Connect (www.cefconnect.com), sponsored by Nuveen Closed-End Funds, offers a free screener that works well for identifying closed-end fund candidates (select Fund Screener on CEF Connect's homepage). Here’s an example of how to use it to find funds of interest.

Fund Types
Closed-end funds fall into two general categories, income (bonds) and equity (stocks). Within those categories, the screener offers numerous choices, such as non-taxable, taxable, emerging market, or international bonds. For this example, I checked the equity tax-advantaged, and growth & income equity categories listed under US Equity funds:. Tax-advantaged means that the fund mostly holds stocks whose dividends qualify for the 15% maximum federal income tax rate. Growth and income funds typically hold a mixture of stocks and bonds.

Monthly Payouts 
Many income-oriented investors prefer securities that pay monthly distributions (dividends), so I selected “monthly” for distribution frequency. I also specified a minimum 5% distribution rate (yield) to isolate funds paying significant dividend yields.

Premium/Discount
Many investors consider that funds trading at premiums to net asset value to be riskier than those trading at discounts (most funds typically trade a discounts). So, I limited my results to funds trading at, or below their net asset values by specifying a maximum zero value for Premium/Discount.

Returns Count
High dividend yields don’t mean much if a fund’s share price drops significantly while you hold it. While historical returns don’t guarantee future results, I’ve found that funds that have chalked up recent positive returns are better bets than funds that have recorded loses. To isolate winning funds, I specified a minimum 10% for “Total 12-Month Return on Price.”

Results
My screen listed 11 closed-end funds.

 BlackRock Preferred and Equity (BTZ): yield 10.8%, 12-month return 39%

 Calamos Strategic Total Return (CSQ): yield 8.8%, return 20%

 ChartWell Dividend & Income (CWF): yield 10.3%, return 19%

 Delaware Investments Div. & Income (DDF): yield 10.2%, return 43%

 Eaton Vance Tax Advantaged Dividend Opp. (ETO): yield 8.8%, return 18%

 Eaton Vance Tax Advantaged Global Dividend Inc. (ETG): yield 7.9%, return 10%

 Gabelli Dividend & Income (GCV): yield 5.9%, return 11%

 John Hancock Tax-Advantaged Dividend (HTY): yield 9.2%, return 24%

 MFS Special Value & Trust (MFV): yield 10.4%, return 50%

 Neuberger Berman Income Opportunity (NOX): yield 9.9%, return 24%

 Zweig Total Return (ZTR); yield 21.6%, return 15.4% 

As is the case for all screens, consider the results to be research candidates, not a buy list.  I don’t have room to describe everything you need to know here. CEF Connect’s Education Center offers basic tutorials, and the Closed-End Fund Association (www.closed-endfunds.com) is a good resource for more advanced information.

published 10/11/09

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