Closed-end funds can be smart investments in choppy, sideways markets like we’re seeing now. But before we divulge the best closed-end funds to buy now, let’s return to the basics of this lesser-known mutual fund type.

investing-in-mutual-funds2Most investors own the open-end type of mutual funds in their brokerage accounts, IRAs or 401(k)s. But you don’t hear much talk or see much press on closed-end funds, which have some distinct features not shared by other fund types.

Closed-End Funds vs. Open-End Funds

Closed-end funds have some similarities to open-end funds. They both have an underlying portfolio with a net asset value, or NAV, and are managed by a professional; both have expense ratios; and both can have capital gains. But the similarities pretty much stop there.

Unlike the conventional open-end funds, closed-end funds issue a fixed number of shares at the fund’s inception. The shares trade on the stock exchange throughout the day. This is different than open-end funds, which trade at the end of the trading day.

The value of closed-end fund shares is based on demand. Therefore, if demand for shares of a particular closed-end fund is high, the price generally goes up. If investors are selling shares in high number, the price goes down.

Another distinct feature of closed-end funds is that they can sell at a premium or a discount. So it you buy a closed-end fund with a share price that is lower than its NAV, you’re getting a discount, which of course is a good thing. And if, after you buy shares, the spread between the closed-end fund’s share price and its NAV narrows, you’ll get a bonus when you sell shares.

But keep in mind that most closed-end funds sell at a discount. So when analyzing closed-end funds, you’ll want to find one with a higher discount relative to similar funds. And as with most any other investment type, you’ll want to buy a fund you think will perform well over your planned holding period. If the closed-end fund’s discount narrows and the NAV is higher than when you bought shares, you’ve done well.

Like open-end funds, closed-end funds come in many types ranging from U.S. stock and bond funds to funds that invest overseas.

So with that in mind here are some closed-end funds to consider buying now.

Best Closed-End Funds to Buy Now

We highlighted a few closed-end funds in February. But here, in no particular order, are three closed-end funds worth considering now:

  1. Adams Natural Resources Fund (NYSE: PEO): If you’re willing to take a bet on the energy sector, this four-star closed-end fund is selling at a discount of negative 15.35%. Therefore once energy makes a comeback, PEO will climb in price and if the discount narrows, you’ll sweeten the profit. The holdings mostly consist of large-cap energy stocks like Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX) and Schlumberger (NYSE: SLB).
  2. John Hancock Premium Dividend Fund (NYSE: PDT): If you’re looking for decent yields now but also the potential for long-term capital appreciation, PDT can be a smart choice. The fund’s distribution rate, which is similar to an open-end fund’s yield, is 6.74%. While the performance for this five-star rated fund beats most stock funds, it employs leverage in its tactics, which is common among closed-end funds. Therefore the high yields and high returns also come with relatively high market risk.
  3. Prudential Short Duration High Yield Fund (NYSE: ISD): You won’t find many closed-end funds that have a balance of qualities like ISD. This four-star fund is selling at a discount of minus 6.09%, its distribution rate is 8.39% and its performance year-to-date is 10.19%. But as always, these positive attributes do not come without risk. The discount spread is narrowing, which can foretell a trend but the discount can also reverse course and widen in the short term. Also the fund recently used leverage on more than 25% of the portfolio.

As a final note of caution with closed-end funds, a steep discount doesn’t imply a bargain and discounted funds tend to remain discounted funds. Furthermore, the discount can narrow or widen. Therefore, an investor’s primary focus should be the share price at which the fund was purchased. And above all, the fund type should be suitable for the investor’s objective and risk tolerance.

Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.

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