Closed-end bond funds trading at discounts
Closed-end funds, or CEFs, are mutual funds that trade on the exchange like stocks. "Following the 3rd-quarter sell-off, a number of closed-end bond funds with solid assets are selling at unusually deep discounts," says Martin Fridson, chief investment officer at wealth management firm Lehmann Livian Fridson Advisors. He favors funds with a mix of investment-grade and high-yield corporate bonds.
While Fridson didn't recommend specific funds, one example is the BlackRock Credit Allocation fund. It invests in investment-grade bonds and junk bonds and trades at about a 12% discount to its net asset value. That gives it a juicy yield of 7.8%. This fund and many others like it use leverage (borrowed money), which can boost returns when interest rates are low but depress returns when rates are high.
In choosing a CEF, Fridson offers these recommendations:
- Look for consistency of return: top quartile performance in 1-, 3- and 5-year performance versus peers and benchmarks.
- Confirm that the management team that produced the superior performance is still in place.
- Verify that the superior performance wasn't the function of a single, aggressive sector bet.
- Look for deeper discounts than the historical average.
- As a bonus, look for price momentum.