A high dividend payout is a good thing whether you're holding a stock, bond or mutual fund. With closed-end funds, a healthy dividend can provide a nice kicker for capital gains on the shares as well. However, the fund could be putting its money into riskier bonds that may end up defaulting. Research the portfolio thoroughly before you buy into a fund.
A mutual fund is a pool of money managed by professionals. It invests in stocks, bonds, or both. An open-end fund sells its shares directly to the public at net asset value (NAV), the value of a fund's assets minus its liabilities divided by the number of outstanding shares. A closed-end fund is available on the stock exchange and its price fluctuates with supply and demand. Closed-ends trade at either a discount or a premium to their NAV. This means you can buy fund shares for less than they're worth on paper and benefit if the price gradually catches up to the fund's NAV.
Some closed-end funds strive to offer comparatively high dividend payouts, but they must buy securities that pay a higher rate of interest to do it. Generally, the higher the interest paid by a bond, the riskier the bond. High-income funds buy low-rated corporate debt as well as "junk bonds" considered to include a risk of default, which would cause a hit to the fund's share price. You can find high-income funds through a fund rating service such as Morningstar. Bond ratings are issued by firms such as Moody's Investors Service and Fitch Ratings.
The key stat on income funds is the distribution rate, the percentage of the fund value that is being paid out to investors. The Pimco Global Stocks Plus and Income Fund, for example, recently paid dividends at a rate of 9.44 percent. However, the fund traded at a premium of 56 percent, meaning the share price exceeded the fund's NAV by that amount. Investors in the fund risk seeing their shares fall if markets tumble and speculators start bidding down the fund.
Closed-end funds can show healthy distributions even if they trade at a discount. The Western Asset Investment Grade Defined Opportunity Trust, for example, recently traded at a 8.4 percent discount and had a distribution rate of 6.1 percent. Distribution rates fluctuate constantly as a fund buys and sells securities. As interest rates rise, turnover in a fund tends to boost the distribution rate. At the same time, rising rates usually reflect falling bond markets and generally increase the discount as market sellers outnumber buyers.
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