The world of closed-end funds (CEFs) offers a compelling, often overlooked, avenue for income generation and capital appreciation, often outperforming their more popular index fund counterparts. This is evidenced by the remarkable success of the Adams Diversified Equity Fund (ADX), a CEF recommended nearly eight years ago that has delivered over 200% returns, significantly surpassing the S&P 500’s performance during the same period. This outperformance translates into a substantial difference in actual returns, with ADX investors enjoying approximately $3,280 more for every $10,000 invested compared to those who opted for the S&P 500. Moreover, ADX has consistently provided a significantly higher yield, averaging 7.3% annually, more than triple the yield of the S&P 500. This superior income generation, coupled with robust capital appreciation, highlights the potential of CEFs to deliver substantial total returns.
The compelling narrative of ADX is not an isolated incident but rather indicative of a broader trend within the CEF universe. Bond CEFs, like the PIMCO Dynamic Income Fund (PDI), have also demonstrated a consistent ability to outperform their benchmarks. PDI, the largest corporate-bond CEF, has significantly outperformed the junk-bond index, delivering over triple the profit in its 12-year history. Furthermore, PDI’s impressive 14% yield dwarfs the 6.6% yield of the junk-bond index ETF. The added benefit of PDI’s dividend growth and special dividend payouts further solidifies its advantage. This performance disparity extends to the municipal bond market as well, with the Nuveen AMT-Free Quality Municipal Income Fund (NEA) outperforming its benchmark index fund and offering a substantially higher yield.
This consistent outperformance and higher income generation across multiple CEF categories begs the question of why these funds remain relatively obscure. Several factors contribute to this underappreciation, including misaligned incentives within the financial industry, a general lack of awareness among individual investors, and the aggressive promotion of index funds by their sponsors. While index funds offer simplicity and diversification, they often fail to capture the potential for higher returns and income offered by actively managed CEFs. The complexities of CEF structures and their limited accessibility through mainstream brokerage platforms also contribute to their relative obscurity.
The occasional surge in popularity of certain CEFs, however, highlights the potential for rapid price appreciation when market sentiment shifts. The PIMCO Corporate & Income Opportunity Fund (PTY), a sister fund to PDI, experienced a dramatic increase in its premium to Net Asset Value (NAV) during the pandemic as investors recognized its outperformance. This surge in demand drove the premium to an impressive 42.8%, providing substantial profits for those who had invested at or near par value. This example underscores the potential for significant short-term gains when CEFs move from undervaluation to premium valuation, further amplified by the high income stream they typically offer.
This dynamic of fluctuating premiums and discounts presents a unique opportunity for savvy investors. By identifying CEFs trading at a discount to NAV, investors can position themselves for potential gains as the discount narrows or even converts to a premium. This strategy allows investors to amplify their returns while simultaneously benefiting from the high income stream generated by the CEF. This ability to capitalize on market inefficiencies is a key advantage of CEFs, and one that is often overlooked by investors focusing solely on index funds.
The persistent discount in many CEFs presents a compelling argument for their inclusion in a diversified portfolio. With hundreds of CEFs currently trading at an average discount of 5.6% and offering an average yield of 8.7%, the potential for profit through discount capture combined with high income generation is significant. This opportunity is further validated by the strategies employed by sophisticated investors like Boaz Weinstein’s Saba Capital, which specializes in identifying and capitalizing on undervalued CEFs. The CEF market offers a rich and often untapped resource for investors seeking both income and growth, providing a compelling alternative to traditional index fund investing.
