The Constraints on Closed-End Fund Managers

In the past, I have been critical on the topic of why you shouldn’t buy closed end funds because they tend to employ significant leverage in an effort to use debt to buy additional assets that can provide capital appreciation and higher dividend yields. During the 2009-2016 measurement period, this moderate leverage strategy worked out well because interest rates were low and the markets moved upward with little volatility.

When interest rates rise, you need higher total returns from the selected investments to keep the gap consistent. That is to say, when you borrow at 3% and earn returns of 9%, that 6% difference represents the value created by your use of leverage. If you borrow at 5%, you have to earn 11% returns at the higher market levels to maintain the same effect, while also exposing yourself to a risk I call “the tyranny of compounding” that refers to … Read the rest of this article!