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Q

I just wanted to see if you would acknowledge the value of closed-end funds (CEFs) that pay 100 basis points more annually than comparable bonds, given your continual encouragement to buy long bonds for income and ignore their price fluctuation, and the futility of trying to guess on rates. Apparently, you will not do so, even outside of the Bond Forum. I guess I understand that this would amount to shooting yourself in the foot with respect to your business, so I certainly understand your position. Your comment about preferred shares makes no sense – one can buy the short-term preferred paper at any time. It is not reserved for institutions. I think what I’m doing – combining individual munis with CEFs for a yield boost, including buying an occasional bond from your company – makes a lot of sense.

A

James A. Klotz responds:

I don’t think you understand our position regarding closed-end funds.

Your conclusions about why we don’t recommend them is inaccurate. We have executed many trades in closed-end funds over the years. This does not mean we recommend them. We’re not suggesting this is the worst investment an individual can make, we just believe other approaches to the tax-free bond market will, over the long haul, prove to be more successful.

You have described our philosophy well; we encourage investors to buy long-term bonds to maximize a dependable and steady stream of tax-free income. We do this with full knowledge that over the life of these bonds, they will sometimes be worth less than the client paid and sometimes more. We can assure them, however, that at maturity their original principal will be returned. This is not true of closed-end funds and we don’t believe that the additional income you are enamored with will make up for the loss of principal. On a $100,000 investment, 100 basis points of additional income will not make up for a 10% or 20% loss in principal.

Closed-end funds do not guarantee the investor will ever have his original investment returned or that his dividend will remain fixed for any reasonable period of time. If rates continue to decline, bond funds will be forced to cut their dividends. We think this could produce the worst of both worlds, i.e. declining market value and declining income.

We agree with your premise that supply and demand principles dictate that an increased number of investors will be seeking fixed-income investments over the ensuing years. We don’t agree with your conclusion that it will be in the form of closed-end funds.

In a business situation, I am sure you can appreciate that even if the demand for your product increases dramatically, your company will only benefit if the ideas and products you recommend perform satisfactorily.

We are not afraid of shooting ourselves in the foot. It is our clients’ feet we are trying to protect.