Liquid, Liquid, Liquid – The Benefits of Closed-End Funds Versus Mutual Funds, Private Hedge Funds, Or Private Alternatives

The mantra for real estate investing is “location, location, location”.

For closed-end funds, I believe it is “liquid, liquid, liquid”.  Where else can you obtain readily available monthly income returns of 7% -15% annually with debt-related or hybrid securities that pay monthly?

While apartment buildings and retail corporate real estate are deemed safe havens and almost a “can’t lose” investment, can one readily buy and sell real estate with a two-day settlement at little or no cost as one could do with bond or debt-related CEFs which trade like stocks with no commissions?

Where else can you get monthly income like rental streams provided by real estate but compound those distributions (or rents to keep the analogy alive) by reinvesting those monthly distributions? Could you take your monthly rent and easily buy another apartment building or retail space and thereby keep compounding your money quickly?  Closed-end funds (CEFs) typically pay monthly allowing for monthly reinvestment that compounds, one of the most appealing advantages relative to other higher-yield investments. 

Moreover, private equity and venture capital have been all the rage the last few years as interest rates were low and they used plenty of leverage to generate outsized returns. Now they are declining given higher interest rates.  Moreover, it is difficult to exit private alternatives or hedge funds as most are issued with lock up periods of five years or greater and with significant multi-million-dollar minimums.

Mutual funds must trade at the end of every trading day at NAV (Net Asset Value) to allow buyers and sellers to come in or get out at the fair market value of what is in that fund that day.  So why is this advantageous?  I have been investing and researching over 150 CEFs in the various income categories of corporate loans, high-yield bonds, preferred stocks, business development companies, emerging market bonds, sovereign debt, and the like for over 10 years.  During this time, I have never seen NAV discounts this large available in each of these categories.   For example, a high-yield bond fund trading at a NAV discount of 20% would imply that you are buying a bucket of bonds at a 20% discount to what a mutual fund with the same exact securities while having tradability not available with mutual funds.

There is more risk with the additional leverage used by most CEFs, but this can cut both ways. In a rapidly rising interest rate environment, CEFs may magnify losses, but the same is true in a stable or lower interest rate environment where one can outperform and magnify the upside.  So if you can capture both a higher rate of distribution on a monthly basis (mutual funds usually only yearly at the end of the year), get tradability, and can capture a NAV discount which is better?