Closed End Bond Funds are Like a Legalized Ponzi Scheme

closed end bond fundsEvery so often, the topic of closed end bond funds will come up in a discussion. Someone will mention that they have found a fund with a consistent high yield. However, with closed end funds yield may be very misleading.


What are Closed End Bond Funds (CEF)?

Just like an exchange traded fund, closed end bond funds trade on the market like a stock. They have a market price that can be above or below the value of their assets (also referred to as Net asset value or NAV for short). However, there are several big differences between exchange traded funds (ETFs) and closed end bond funds (CEFs):

  • The number of shares of an ETF available for trading is dynamic. A closed end bond fund has a fixed number of shares that does not change. When the price of an ETF is below the value of its underlying assets (NAV), there is a natural process which results in the reduction of the number of shares of the ETF available for trading (you can learn more about this on our Bond ETFs page. Conversely, more shares are created when the price is above its NAV. This generally results in the price of the ETF in the market and its NAV staying within a few percent of each other. Closed end bond funds do not have this mechanism, and therefore often trade at a 5 to 20% discount or premium to their NAV.
  • ETFs cannot increase their leverage by borrowing money. Closed end bond funds frequently borrow money to increase their leverage.
  • ETFs payout all income and capital gains they generate, no more and no less. Closed end bond funds can pay more or less than the income and capital gains they generate.


What is the attraction of closed end bond funds?

There are three arguments that are used to promote closed end bond funds:

1) Closed end fund Managers are better positioned to focus on the long term than a typical mutual fund manager. When money is leaving a mutual fund (en masse), a fund manager must sell assets to raise cash. As a result, mutual fund managers tend to avoid assets that are not very liquid, even if non-liquid assets are better investment opportunities.

If many clients withdraw funds from a closed end bond fund, the value of the fund’s shares will drop, however the fund manager is not forced to sell assets.  This means that closed end funds can more easily buy less liquid assets and focus on the long-term.

Our problem with this thinking: I am not 100% convinced that less liquid assets provide better investing opportunities. There have been a number of studies indicating that funds which invest in non-liquid assets generally do not do better than those investing in the liquid assets.

2)  Leverage provides an opportunity for greater profit. If you like a type of investment or manger, why wouldn’t you want to give the manager a chance to make more money by borrowing?

Our problem with this thinking: Leverage means more risk as well.

3) The biggest advantage the people cite is the consistent, high monthly distribution payments.  The problem with this advantage is that these payments are often derived using smoke and mirrors.


Here is why this can be little more than a legalized Ponzi Scheme

Many well known closed end funds like the PIMCO High Income fund, pay high consistent dividend payments. Every month like clockwork, PIMCO delivers a distribution of 12.19 cents per share. If you are living on a fixed budget, knowing the amount that you will receive each month is very attractive. With most bond ETFs and bond mutual funds, the amount varies each month, making budgeting difficult.

One would assume that these distributions come from interest income or investment gains. WRONG! Often times the fund has been selling assets (reducing the fund’s NAV) to provide these dividends, basically using a portion of the money invested in the fund to pay out the dividend. This is one of the major reasons why the NAV for the PIMCO High Income Fund is around half of the initial share price of the fund. As more of the fund’s assets are depleted, it has  to use more of its assets to pay distributions, creating a vicious cycle. Basically, this is what happened with Bernie Madoff. The difference is that Madoff hid the fact that he was using investor’s capital to pay distributions, claiming it was profits. This story does not end well for investors either way.

More Reasons Why We Don’t Like Closed End Bond Funds

  • High Annual Expense Ratios
  • High Cost Of Exiting A Position. The bid/ask spread, the difference between the price which you can sell and buy a closed end fund is very high compared to ETFs or stocks. If you were to buy a fund and then immediately sell it, you would typically lose half to a full percent.


Big Surprise! Closed End Bond Funds Aren’t That Popular

The three biggest closed end municipal bond funds are all run by Nuveen Investments: Nuveeen Municipal Value (NUV), Nuveen Municipal Opportunity (NIO), and Nuveen Premium Income Muni 2 (NPM). Collectively there is less than $5 billion invested in these funds.

The three biggest taxable closed end bond funds are run by three different firms: AllianceBernstein, Aberdeen, and Eaton Vance. Collectively, there is less than $7 billion in these funds.

The top three taxable bond and municipal bond closed end funds together have less than $12 billion dollars in investments. This is less than 1/20th of the amount the top bond mutual fund (Pimco Total Return fund) has. The market has made its decision. Closed end funds are not very attractive.

For more on bond mutual funds and ETFs, visit the Bond Funds section of Learn Bonds.


  1. Kady says

    All the issues raised above are true, but manageable. The argument is sufficient to advise a person not to make CEF’s permanent, core holdings in a portfolio, but insufficient to advise against making them a tradable asset as part of a diversified portfolio: Specifically:

    1) Less-liquid assets aren’t really the issue; the issue is that CEF managers are less constrained by structures and regulations, permitting them more freedom to optimize their portfolios according to their choosing. This is neither good nor bad; it just means that CEFs may be less appropriate for buy and hold investors than ETF’s due to the need to monitor the fund’s portfolio to determine risk.

    (Put another way, a CEF manager can get pretty far off the reservation into high risk/reward land. This is a benefit to sophisticated investors, not necessarily one to those who are unsophisticated.)

    2) Leverage does mean more risk, but the risk-conscious can easily monitor the standard deviations of CEFs on sites like Morningstar. There exist an ample supply of CEFs with volatilities well below the S&P than return more and pay out regularly.

    3) Not all CEFs practice managed distributions, which holds the distribution rate equal even if the fund has to pay you with your own money. These are easily screened out using the screener at

    4) CEF’s on average do have high expense ratios, but there are ample low-ratio selections to choose from. Don’t buy a CEF that has a ratio above that of a mutual fund serving the same market niche. Simple.

    5) High exit costs: I suppose this is true (l’ll take your word for it), but if true, it simply disqualifies CEFs from use as a short-term trading vehicle. Some mutual funds have large loads, others have surrender fees. Smart investors manage their trades around the specifics of the fund; CEF’s are no different.

    Personally, I use CEF’s often, particularly when I want to be bond-heavy in my portfolio, to maximize gains during those periods. I am currently 20% in CEFs and loving it.

  2. Azrstuff says

    Ponzi Scheme? You need to learn teh definition. I don’t like Pimco. I’ve never owned a CE Muni fund, but you’re just wrong.


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