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Closed-end funds enjoying resurgence, expert says

Thomas Herzfeld opens up about closed-end funds

By Dian Vujovich
Special to the Daily News

Why Thomas Herzfeld knows what he knows about CEFs

It's no secret that Herzfeld is the guru of the closed-end fund industry. In addition to providing Wall Street with closed-end fund research, authoring a number of books and creating the only Closed-End Fund Index around, a closer eye reveals that it might be his wife, Rutli, who was responsible for Herzfeld's success within this segment of the market. Here's how that story goes: After Herzfeld got out of the Army in 1968, he wasn't hired by the folks at Herzfeld & Stern in New York City because they thought he wasn't likely to make it in the business, so he joined the investment firm of Reynolds & Co.

While dating professional model Rutli, now his wife, she asked him to open an investment account for her. Herzfeld agreed and purchased her shares of The Chase Convertible Fund, a closed-end fund.

After a few months of owning the stock, Rutli asked why the shares purchased for the dividend reinvestment program she was a participant in were bought for around $10 a share when the stock typically traded between $9 and $10 throughout the month. The young broker Herzfeld didn't know the answer, so he asked around.

The first call was to his firm. No one there had the answer but suggested he call the fund's transfer agent. The representative at the transfer agency didn't know, either, and thought he ought to phone the stock's trader. He also didn't have an answer but, according to Herzfeld, said, "If you think you can do a better job, you do the order."

And so it began. Herzfeld got the order to buy 30,000 shares of this thinly traded stock each month and found an investment strategy that allowed him to purchase shares around $9 a share. The rest, as they say, is history.

Today, Herzfeld's Miami firm has grown in client base, employees and product diversity: Far beyond that of his Herzfeld Caribbean Basin Fund (CUBA), Herzfeld has added an open-end mutual fund to his roster. The Virtus Herzfeld fund (VHFAX) is a balanced fund of funds that invests in closed-end funds. In addition to increasing the firm's management team, his two adult children, Erik and Brigitta, are principals in the firm along with long-time employee Cecilia Gondor.

The changing closed-end fund IPO market

Interest in closed-end fund initial public offerings (IPOs) has grown substantially over the years. In 2008, only two offerings came to market: The BlackRock Defined Opportunity Credit Trust and the Morgan Stanley Frontier Emerging Markets Fund, according to Herzfeld research. Through May 1, 2013, there have been 10 with $9.23 billion raised. A few of the investment firms issuing them, include names such as PIMCO, Nuveen Neuberger Berman, Eaton Vance and Cohen & Steers.

To research the more than 600 closed-end funds in the marketplace, visit: Herzfeld.com, then click on "Links to funds."

Source: Thomas J. Herzfeld Advisors Inc.

For the income- and opportunity-conscious, there's an often overlooked place to invest: closed-end funds.

Different in structure, sales and pricing than open-end mutual funds, CEFs haven't garnered the attention that open-end mutual funds have, even though they've been around much longer.

Perhaps that's because they have no out-front sales team pitching them like open-end funds do. Or, it could be that they're not quite as sexy as their cousins -- and certainly more confusing.

Whatever the reason, if you're looking for the premier expert in the CEF arena, there's only one man to turn to, Thomas J. Herzfeld.

If the Herzfeld name sounds familiar, the investment firm of Herzfeld & Stern had a presence in Palm Beach a few decades back. In 1980, for instance, to celebrate the 100th anniversary of the company's membership in the New York Stock Exchange, the office moved its Palm Beach branch from North County Road to new digs at the Royal Poinciana Plaza. A few years later, Josephson International purchased the firm. Then it was bought by Gruntal & Co. That firm has subsequently been sold a few times.

The Herzfeld in the Herzfeld & Stern brokerage name was that of a shirttail relative of Thomas Herzfeld. "He was a distant cousin of my grandfather," says Herzfeld, who is chairman and president of the Miami-based Thomas J. Herzfeld Advisors Inc., a specialist in closed-end funds for more than four decades.

Unlike open-end funds, which must meet shareholder redemption demands daily and are always issuing new shares for sale, only a limited number of a closed-end fund shares are issued when the fund comes to market as an initial public offering. Because of that, CEF managers are able to do things such as invest in less-liquid stocks than open-end mutual fund managers. Hence, there is attractiveness to these products other types of securities don't offer.

Some CEF history

"Going back to the 1800s, closed-end funds were a way people invested in emerging markets," says Herzfeld, who opened his firm in 1984. "It started with the British investing in Argentina in the 1890s."

What followed were funds that invested in North America in the 1900s, in Japan following World War II, in a Mexican fund in the 1980s, as well as in South African funds, says Herzfeld, who's been called "Mr. Closed-End Fund" because of his knowledge in the industry.

"The closed-end fund structure is ideal for investing in emerging markets because closed-end funds don't have to take in new money and meet redemptions at the whims of their shareholders," Herzfeld said.

What began as a unique way to play the emerging markets is now a $300 billion industry composed of more than 600 funds offering a host of investment opportunities, from general equity funds to mortgage bond funds, world income funds, municipal bond funds and more.

Uptick since last year

Like every other investment impacted by market downturns over the past few years, interest in CEFs had waned but now is enjoying a resurgence. Cecilia Gondor, a principal at Thomas J. Herzfeld Advisors, said the interest in CEFs really began last year. "In 2012, there were 22 publicly traded closed-end fund IPOs that came to market and brought in $11.6 billion. In 2008, there were only two (IPOs)," she said.

But while a corporate stock IPO might make a hot stock pick, the same isn't necessarily true when that stock is a closed-end fund.

A closed-end fund's per-share price is determined by the net asset value, or NAV, of the fund's holdings along with investor interest -- supply and demand. Consequently, the share price an investor pays may be one that's trading at a discount or premium to the fund's NAV.

"Someone has to buy CEFs at the IPO. But it shouldn't be you," says Jeff Tjornehoj, head of Lipper Americas Research. "Few funds can maintain the post-launch premium, so buying one at IPO can be a big mistake."

As for performance, April was the first in the last four months in which equity and fixed-income CEF's posted positive gains, according to Lipper research. Thirty percent of the funds in April traded at premiums.

Then there's the income CEFs can provide.

Reports show that CEF yields can be greater than those on many mutual funds and even exchange-traded funds. According to Gondor, the average distribution rate on taxable-bond funds is currently about 6.95 percent: On tax-free municipal CEFs, it's about 5.4 percent.

While those yields may be seductive, it's important to know where that yield is coming from.

"Closed-end funds can be interesting if they sell at a discount to NAV, "says Robert Harvey, of Harvey Capital Management. "But some of them use leverage to provide their income. And leverage can work your way when interest rates are low and until rates go up. When they do go up, then suddenly, leverage doesn't work for you."

Tjornehoj echoes Harvey's concern: "Leverage can boost returns but it can also work against you and may be a double-edged sword." He added that anyone interested in CEFs mustunderstand where the fund is getting its yield and the difference between yield and a fund's distribution rate.


No doubt, closed-end funds are investments that have been time-tested and are here to stay. They're also investment products that could fit into more portfolios than many think.

But like everything Wall Street, there's plenty to consider before investing. In addition to learning where a fund's yield is coming from, Harvey suggests interested CEF investors first consider a fund's fees, taxes and the mood within the overall market place.

From Herzfeld, it's "discount, discount, and discount." Meaning: Don't pay too much for fund shares because the NAV typically doesn't stay at a premium for long. One exception: Herzfeld said this year CEFs have been trading at a premium longer.

Finally, the research.

If there's one reason Herzfeld's firm has a 40-plus year history, it's probably a research-based one.

Every day, by hand, Herzfeld charts the performance of some 600 funds, while his son Erik (a principal at the firm) charts them on the computer, and Gondor's selections are made via hard-core research.

Which technique winds up being the most profitable?

"Interestingly, we pretty much come with the same buys and sells," says Herzfeld. "So I don't know who is the best, but I know that it's a pretty good team."

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