One of the biggest hallmarks of using closed-end funds (CEFs) for portfolio construction is the fact that they trade on the major exchanges after their IPOs. Because of this, their share prices can trade at different prices from their net asset values (NAVs) or what they are actually worth. For many investors, this allows them to pick up assets for pennies on the dollar. And as such, buying CEFs at a discount to NAVs has become the rallying cry for many CEF investors.
But maybe we should always think about that discount.
Buying a closed-end fund at a premium to NAV does have merit in some cases. For investors, the idea may be to focus on total returns and distributions rather than simply looking at discounts to NAV.
How Discounts In CEFs Form
The uniqueness of CEFs stems from their structure and how they operate. Open-end funds, such as mutual funds or ETFs, can create new shares as investor capital flows into the fund. Conversely, the same is true when investor capital leaves. Mutual funds sell assets and use their cash on hand, whereas ETFs go through the creation and redemption mechanism to adjust their share count.
But the “closed” in the CEF name implies something different.
Managers and fund sponsors will launch an IPO for a new CEF issuing a fixed number of shares at a set price. Those shares then trade on the major exchanges. When investors buy or sell, they are operating like any other stock or bond and purchasing them directly from other investors. This buying and selling creates the supply/demand and, as such, share prices will fluctuate accordingly. But underneath that are the assets of the fund, which are “static”. No new investor capital flows into or out of the fund.
This causes the share price to float around the underlying value of the fund. A quirk that allows investors to buy CEFs at discounts or premiums to their net asset values. For example, if a CEF is trading at a 10% discount to its net asset value (NAV), you effectively get a dollar’s worth of assets for 90 cents.
For many investors, the ability to pick up assets for pennies on the dollar has become the rallying cry for investing in CEFs. After all, why would you pay more for something than what it is worth? Many market pundits have supported this notion, with some going so far as to say “avoid all funds not trading at a discount to NAV”.
To that end, CEFs at a Nav discount are the only ones to bet on.
Looking Beyond the Discount
However, the focus on discount-to-NAV buying could be doing investors a disservice when it comes to the CEF structure. The reality is that the discount may not be everything, and that buying a premium may also be warranted.
For starters, there have been plenty of times when the entire CEF universe, on average, has been trading at premiums to NAVs. This is particularly true during periods of low interest rates or periods of rate cuts. Thanks to their ability to use leverage, bet on illiquid assets, and use managed distribution plans, investors are able to pick up plenty of extra yield by using a CEF over an ETF or mutual fund. When yield is scarce, as during periods of rate cuts or low interest rates, the extra yield from a CEF is advantageous. As such, the entire universe of CEFs moves higher. This chart from BlackRock shows that there have been plenty of multi-year periods where the average CEF has traded at a premium to net asset value.
Source: BlackRock
The shift from premium to discount doesn’t necessarily mean that investors have realized negative returns. In fact, it may be quite the opposite. That’s because when it comes to CEFs, distributions and total returns are what actually matters.
The bulk of CEFs are designed to provide attractive, regular distributions to shareholders. This includes equity-based funds. While narrowing discounts to NAV can contribute to total returns, data supplied by asset manager Aberdeen shows that over long periods, distributions become an increasingly larger positive component of total return, while the change in discounts contributes increasingly less to total return. Dividends and distributions matter more. 1
The proof is in the pudding.
A study by Reuters, which looked at the largest 30 CEFs, showed that funds bought at deep discounts underperformed, while those that traded at premiums delivered more consistent and often stronger returns. According to the data, the top-performing fund, which began the year at the highest premium, delivered a 19.9% total return, while the worst-performing premium-trading fund posted a respectable 17.2% return. For comparison, the S‑Network Composite Closed‑End Fund Index managed to post a 16.6% return. When looking at discount-to-NAV funds, the results had far more dispersion, producing results that included negative total returns and index underperformance. 2
Overall, discount to NAV is not a great predictor of strong total returns.
Deprioritize The Discount & Focus On Distributions
Investors considering CEFs for their portfolios shouldn’t only consider discounts to NAV when selecting funds to purchase. There’s more nuance to it. Some CEFs may trade at premiums or discounts to the NAV over extended periods, influenced by factors such as yield premiums or the manager’s performance. For example, many of PIMCO’s CEFs traded at very wide premiums to their NAVs for years, thanks in part to the fact that they were managed by Bond King Bill Gross.
A better solution is to focus on what’s called a z-score. By definition, a z-score indicates whether a fund is trading above or below its average valuation over a specific period, as well as the magnitude of that deviation, represented by the current premium or discount. This gives a much more accurate picture of whether a fund is cheap or expensive. Funds that trade at premiums tend to stay trading at premiums, while deep discounted funds tend to stay at discounts.
Top-Performing CEFs
These CEFs are sorted by their YTD total returns, which range from 6.5% to 15.8%. They have AUM between $100M and $1.65B and expenses between 0.86% and 3.4%. They are currently yielding between 6.1% and 13.1%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type |
|---|---|---|---|---|---|---|
| XAGIX | abrdn Global Infrastructure Income Fund | $610M | 15.83% | 12.66% | 2.04% | CEF |
| XAEFX | abrdn Emerging Markets ex-China Fund | $344M | 13.02% | 10.4% | 2.04% | CEF |
| XIAFX | abrdn Australia Equity Fund | $130M | 12.07% | 10.4% | 1.94% | CEF |
| XJEQX | abrdn Japan Equity Fund | $93M | 11.97% | 6.09% | 0.83% | CEF |
| XBGRX | BlackRock Energy Resources Trust | $380M | 9.6% | 6.1% | 1.29% | CEF |
| XJQCX | Nuveen Credit Strategies Income Fund | $790M | 9.2% | 13.1% | 2.67% | CEF |
| XJFRX | Nuveen Floating Rate Income Fund | $1.22B | 8.7% | 12.8% | 3.4% | CEF |
| XBGTX | BlackRock Floating Rate Income Trust | $285M | 8.2% | 12.1% | 3.05% | CEF |
| XBDJX | BlackRock Enhanced Equity Dividend Trust | $1.65B | 7.3% | 9.1% | 0.86% | CEF |
| XJLSX | Nuveen Mortgage and Income Fund | $104M | 7% | 10.8% | 1.57% | CEF |
| XJPCX | Nuveen Preferred Income Opportunities Fund | $783M | 6.5% | 9.3% | 2.68% | CEF |
Overall, discount seeking in CEFs has become the rallying cry for many investors looking at the fund form. But the truth is, a discount to NAV doesn’t make or break returns. Those funds trading at premiums may be a better buy for some asset classes or funds. Digging deeper before making a purchase is paramount. Examining z-scores and total returns through distributions is the key to success.
Bottom Line
The beauty of CEFs is that they can trade at a discount to their actual net asset value. But focusing on that discount may be doing investors a disservice. Sometimes, paying a premium may yield better results. A discount to NAV isn’t the end-all be-all.
1 Aberdeen (February 2024). Closed-end funds: Deprioritize the discount
2 Reuters (April 2025). Don’t confuse discounts to NAV with bargains: Fridson
