Built to Borrow: What Makes Leveraged Closed-End Funds a Smart Income Play

Another is their ability to juice returns.

Leverage is one area where closed-end funds outshine ETFs and mutual funds. The ability to take a little debt to increase asset bases has a wonderful effect for investors. This includes boosting distributions and income, without taking on really any extra risk. For investors, choosing a leveraged CEF is almost a no-brainer.

Unlike mutual funds and ETFs, CEFs aren’t open in the sense that they can’t create new shares. Managers and fund sponsors will launch an IPO for a new CEF, issuing a fixed number of shares at a set price, which will then trade on the major exchanges.

This creates the unique benefit of using the CEF structure for both investors and managers.

This includes the ability for investors to purchase assets potentially at discounts to their fair value. And since managers don’t have to worry about redemptions from the fund, they can buy illiquid assets, such as municipal bonds and bank loans.

The fact that managers don’t have to worry about redemptions from the fund also allows CEFs to do something that mutual funds and ETFs can not do. And that’s employ leverage.

Leverage is essentially borrowing money to buy more assets. This can be done to boost returns or increase distributions. Because of the lack of redemptions, CEFs have a more stable asset base, and with that, managers can utilize this asset base to borrow and increase the total amount of money they have to work with.

CEFs can use several different types of leverage, which are often categorized as either structural leverage or portfolio leverage. Portfolio leverage encompasses options such as tender option bonds or derivatives. These activities are NOT regulated by the Investment Company Act of 1940.

Structural leverage is regulated and is the most common type used by CEFs. This is when a CEF issues debt or preferred shares. According to Nuveen, more than 70% of all CEFs use this type of leverage. The Investment Company Act of 1940 limits the amount of leverage a fund can use to 33% of assets if using debt and 50% if using preferred stock.

So, why bother in the first place? What’s the point of using leverage in a portfolio? The short answer is better returns- in both asset prices and distributions.

The magic is that a CEF will often borrow at short-term rates, while investing on the long end of the curve. Remember, a CEF manager doesn’t have to worry about shareholders leaving the fund. They can buy a 10-, 20, or even 30-year bond and hold it till maturity. In a normal market, shorter-term bonds/loans often charge/yield less than longer-term ones. By borrowing short-term and owning long-term, a CEF can generate additional returns on the carry.

This carry can present itself when it comes to fund distributions. After paying the interest expense on its borrowings, the extra yield can be distributed to shareholders as a return. This table from BNY Pershing compares a leveraged CEF to a non-leveraged fund, illustrating how a modest amount of borrowing can lead to a larger distribution. As you can see, the extra leverage of the CEFs results in an additional 1% in yield for shareholders.

Source: BNY Pershing

According to data researcher and CEF specialist RIA, Closed-End Fund Advisors, by using leverage, the average municipal CEF can get an extra 1%+ of yield; taxable bond & REIT CEFs get 2%; MLP CEFs get 3%; while business development companies (BDCs) CEFs can get an extra 4%+ in yield when deploying leverage. ¹

In addition to the yield boost, investors may also receive additional returns on the NAV and actual value of investments within the CEF. That’s because employing leverage allows the manager to buy more assets. As those assets appreciate or return their principals, managers can score valuable capital gains additionally, if they purchase bonds at a discount, which often occurs with longer-dated maturities. Holding them to maturity creates instant gains as the principal is repaid. After loans are repaid, the remaining amount is considered profit.

However, there are some risks associated with leveraging. Just like a hedge fund manager, leverage can work against you during bad times. This can include greater NAV volatility or even distribution cuts. If short-term borrowing interest rates increase, but the net income of a CEF remains constant, there is a decrease in the fund’s net earnings. If that amount is below the current distribution, it results in dividend cuts.

As for NAV volatility, a leveraged fund may underperform a non-leveraged one as asset prices decline. For example, examining high-yield bond CEFs during the 2008 credit crisis, unleveraged funds lost 8.65% that year. The average leveraged CEF in high-yield bonds was down by nearly 17%.

Ultimately, the ability to utilize leverage is a hallmark of the closed-end fund vehicle. Thanks to its structure, managers can opportunistically use leverage to boost returns, distributions, and asset bases of the funds. While it can create some volatility and potentially lower returns in downward markets, many managers use leverage effectively to provide more wins than losses.

For investors, using leveraged CEFs in a portfolio is a straightforward solution to enhance their yields and returns. And with the majority of closed-end funds employing leverage, adding this “boost” is indeed very easy.

These CEFs are sorted by their YTD total returns, which range from 6% to 15.8%. They have AUM between $93M and $1.5B and expenses ranging from 0.83% to 4.3%. They are currently yielding between 6% and 14.2%.

Leverage and closed-end funds go hand-in-hand. The fund vehicle’s unique structure allows managers to use leverage to their benefit and to the benefit of shareholders. While leverage is often thought of as scary, thanks to regulations, the use is limited- providing just enough “oomph” to make a difference on returns.

Thanks to their structure, closed-end funds can provide some benefits that ETFs and mutual funds can not touch. That includes the use of leverage in a portfolio. By borrowing under regulated limits, CEFs can increase their returns and provide larger distributions to investors.

¹ Financial Planning (June 2025). Closed-end funds: A close look at leverage?