Investors are always looking for the newest strategies and tactics to extract profits from the financial markets. Newer and faster is often believed to be superior to the old, traditional ways of doing things.
Thanks to technology, this belief holds particularly true when it comes to the financial markets. Today, with the advent of personal computers, stock-screening programs, technical analysis tools with hundreds of built-in indicators, and near-instant news services, investing is easier and more efficient -- and hopefully more profitable -- than ever.
However, sometimes it pays to slow down and look back at the old ways of doing things. Taking a step back and slowing down provides an opportunity to locate an overlooked and mostly forgotten money-making tool, method or strategy that remains a solid edge in today's market.
I rediscovered one such strategy -- a way to purchase financial assets at a discount -- that was first used more than a century ago, in 1893. These investments are often passed down from generation to generation, and they keep on churning out profits for each new holder. Some even have been in continuous operation for the past half-century with the same management team in place. While there are over 600 of these investment companies operating today, their popularity has mostly been usurped by exchange-traded funds (ETFs) and traditionally structured mutual funds.
These time-proven moneymakers are called closed-end funds. Closed-end funds are often offered at a discount to the net asset value of the holdings, offering investors the ability to purchase financial assets at less than market price. Here's how they work.
A closed-end fund is a publicly traded investment company that can use a variety of strategies and invest in multiple types of instruments. Closed-end funds are launched with an initial public offering and then listed and traded on a stock exchange. However, the shares are not sold or cashed in by the company itself. The term "closed-end" refers to the fact that once all the shares in the IPO are sold, no more shares will be issued.
Closed-end funds are actively managed, with the total market price of the financial instruments held by the fund determining the net asset value (NAV). Often, the fund's market price will not match its NAV because the fund's price can be independently affected by market factors. Should the fund fall out of favor, its share price will drop despite its holdings collectively being worth more than the market price of the fund's shares. The opposite can also be true, with the fund's shares selling at a premium to its NAV.
As mentioned, the returns on closed-end funds can be quite impressive; several have posted returns of nearly 50% this year. Here are two examples:
NexPoint Credit Strategies Fund Common (NYSE: NHF)
This closed-end fund is up 32% this year and trades at a nearly 14% discount to its NAV. As its name suggests, the fund invests in below-investment-grade debt and equity, which it has the ability to hedge. NHF pays a monthly dividend of $0.05 -- giving this bargain fund a solid 7.3% yield at recent prices.
H&Q Healthcare Investors Common (NYSE: HQH)
The top-performing closed-end fund this year, HQH has scored a return of close to 50% -- but is trading at a 2.4% discount. This fund invests in health care and medical technology firms, securities with legal restrictions to resell like private shares, and foreign securities. HQH recently paid a quarterly stock distribution of $0.44 -- giving it a 7.2% yield at recent prices..
Risks to Consider: Closed-end funds have higher fees than ETFs due to their more active management, and the buying and selling underlying their activity could have tax consequences. In addition, the usual market risks apply to closed-end funds, so choosing wisely is critical, regardless of past returns or discount to NAV.
Action to Take --> Study the variety of closed-end funds to see whether adding one or more to your portfolio makes solid investment sense.