Municipal Bond Forum
Avoid Risky Closed-End Funds
Q
I’ve been eyeing closed-end ETFs like Nuveen’s NKR, where tax-free yields are around 7%. I’ve made only a token investment there so far, but I’m thinking of investing more in similar funds. Your article on closed-end funds gave me second thoughts. How much do you think an investor should risk in leveraged bond funds?
A
James A. Klotz responds:
We don’t believe that investments should be made with borrowed money (leverage), whether in a closed-end fund or margin account. The current financial crisis that has changed the face of Wall Street forever was brought about, for the most part, by the excessive use of leverage.
We are always concerned when “financial engineering” creates a product which promises greater returns than the underlying instrument produces.
We recommend buying a high-quality bond with a fixed maturity date yielding approximately 6.50% rather than an artificially produced 7.00%. On $100,000.00, the difference in income is only $500.00 per year. Considering that we have all now seen how leverage performs on the downside, this sacrifice is hardly significant.
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