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Closed-End Fund Rules of Thumb

December 13, 2011
You should always do your own due diligence on a fund manager, holdings and sector, but here is a starting point for CEF review. Of course these guideline do not  guarantee success and every investor’s needs and risk tolerances are different. These must be included in your investment decisions and we recommend seeking the help of a full-service financial adviser or financial planner.
  • Investors like CEFs because of discounts and dividends, but never buy a CEF just for a discount or a future dividend rate.
  • Compare NAV Total Return Performance for Peer Funds as it’s the best way to compare managers success.
  • Buy at a discount wider than the one year, 6 month or 90 day average discount to net asset value (NAV).
  • Peer fund and historical discounts for the fund are more important than a current absolute discount
  • Look for dividend coverage and positive (and recently reported) undistributed investment income (UNII) data for funds where income is a significant portion (5%+) of the dividend as it helps avoid a dividend cut and could help identify a dividend increase.
  • Avoid funds where the dividend has a high amount of return of capital  (ROC) – the primary exceptions are Real Estate Investment Trusts (REIT) Funds, Master Limited Partnership (MLP) Funds and Covered Call (option writing) Funds where ROC is often due to the underlying dividends of the investments vs. the fund paying you back your principal. Being paid back your principal rarely makes fundamental investment sense.

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