Income investors who want to protect themselves against rising interest rates might want to consider closed-end funds with diversified portfolios and high yields.
You have probably read warnings in the financial media about bond prices falling as rates increase. A typical story may say “sell your bonds now,” with the idea that investors trade bonds the way they trade stocks, looking for capital gains.
But if you invest for income, selling out of the fear of rising rates simply means giving up cash flow that can amount to $1,000 a month for every $100,000 invested. (See a list of funds, below.)
“You have money every month to use or to put back into the market,” said Mark J. Grant, chief global strategist at B. Riley/FBR/Wunderlich Securities, in an interview Jan. 11. “So you can adjust as interest rates go higher or lower.”
In other words, you will have so much money coming in, you can periodically buy more income by investing at current prices and yields. This approach is part of what Grant believes investors should do with “your safe money or your core assets.”
The list was provided by Grant as a follow-up to his list of six favorite closed-end funds that invest in energy partnerships.
Grant pointed out that, for all the hemming and hawing last year about the Federal Reserve’s moves to increase short-term interest rates and plan to wind down its balance sheet, long-term rates, as represented by the yield on 10-year Treasury notes TMUBMUSD10Y, +0.44% ultimately didn’t move much. The 10-year yield is now hovering around 2.56%. But at the end of 2017, it was 2.40%, down from 2.45% at the end of 2016.
Closed-end mutual funds generally distribute income quarterly or monthly. If your income is being paid monthly, compounding gives you another 1.1% of yield, according to Grant.
After we published Grant’s previous list of closed-end funds, a reader questioned the funds’ use of leverage to increase returns, especially in a rising-rate environment.
Grant, in response, said “just about everything has leverage,” naming Apple Inc. AAPL, +0.57% and Amazon.com Inc. AMZN, +1.78% as examples. According to data from FactSet, Apple’s ratio of debt to equity was 38.9%, while Amazon’s was 54%, as of Sept. 30.
“The maximum leverage for a closed-end fund is 50%. Most of them have leverage in the 20% to 30% range,” Grant said.
When asked about special risks for investors in closed-end funds, as opposed to open-end mutual funds or exchange traded funds (ETFs), Grant said: “The only one is that some of them, not all, are less liquid,” making them hard to buy and sell. As a result, he tends to select funds with average daily trading volume of at least around 100,000 shares.
The following are eight of his favorite closed-end funds, based on the risk profiles of their investments. Some are held by private or institutional clients he advises, and he himself owns some of them.
| Closed-end fund | Ticker | Distribution yield | Premium or discount to NAV |
| Brookfield Real Assets Income Fund Inc. | RA, +0.29% | 10.03% | -5.89% |
| Pimco High Income Fund | PHK, +1.31% | 12.50% | 13.11% |
| AllianzGI Convertible Income Fund | NCV, -0.77% | 10.85% | 5.79% |
| AllianzGI Convertible Income Fund II | NCZ, +0.60% | 10.97% | 3.15% |
| Franklin Limited Duration Income Trust | FTF, +0.17% | 10.55% | -4.13% |
| Clough Global Opportunities Fund | GLO, +0.54% | 10.91% | -9.90% |
| Virtus Global Dividend & Income Fund Inc. | ZTR, +0.04% | 10.12% | 4.94% |
| Calamos Convertible Opportunities and Income Fund. | CHI, +0.63% | 10.23% | -0.98% |
| Source: Morningstar | |||
Like open-end funds, closed-end funds have net asset values (NAV) that are calculated by dividing the fund’s assets by the number of shares. But a closed-end fund is publicly traded, so its share price can trade at a premium or discount to NAV, as shown on the table.
Those funds are best thought of as long-term income investments. Long-term means a commitment for many years, so that you can take advantage of the steady stream of cash. The funds’ portfolios vary, so it is best to do your own research and consider a fund’s portfolio and strategy before buying.