Get Fast Investment Income with Closed-End Funds

In the hunt for low-risk, high-return investments, exchange-traded funds (ETF) and real estate investment trusts (REIT) have become increasingly popular with investors. Some of these products offer eye-popping returns; for example, Hatteras Financial Corp. HTS is an externally-managed REIT currently offering quarterly dividends of $1. On a stock trading at around 25.60, that is an annualized return of over 15%!

The downside, of course, is risk. Hatteras began the year trading in the $30 range and is only slightly above its 52 week low of $22.33 per share. Investors, particularly retirees, are drawn to REITs because they provide a semi-reliable source of regular income, but their volatility translates into a greater level of risk than many retirees are comfortable with.

A high-yielding but lower risk bet may be a class of high-yield closed-end funds (CEF)--some of these have shown a robust stability in recent years, even as the market has reached record levels of volatility. While the Volatility S&P 500 (^VIX) swings wildly, many high-yield closed-end funds have remained almost flat.

However, many investors are unfamiliar the CEFs. They are similar to exchange-trade funds in that they are traded as shares after an IPO raises a certain amount of money that is then invested according to the fund's mandate. Muncipal energy CEFs, for example, will invest in utility companies. After the fund has invested its money, the CEF is listed as a stock and sold on an open market.

The important point of the closed-end fund is that there is a fixed number of shares, and the CEF cannot issue more shares at any point. Fixing the supply of the stock helps to limit investors' exposure, but the price of the CEF will still fluctuate according to demand for it on the open market.

To illustrate how this works, let's take a look at a rather well-performing example: the Wells Fargo Advantage Utilities and High Income Fund ERH. This fund has a market cap of a little over $100 million, which has been invested in mostly in utilities, but also in a wider range of holdings to minimize risk. You can see a detail of the fund's holdings here.

For 2011, the fund has been offering an annualized dividend slightly above 8.2%, which is slightly below previous years. As with most closed-end funds, the stock's price has dropped relative to its dividend yield, meaning that anyone investing in a CEF is wise to track its dividend announcements and respond swiftly.

However, even with a lower dividend yield, 8.2% is still very high. Additionally, since CEFs are publicly-traded stocks with a fixed number of outstanding shares, CEFs are much easier to jump in and out of than mutual funds.

While investors cannot rely solely of CEFs, they are an often overlooked and useful component to a well-diversified portfolio, especially if the goal is to produce income by investing in a specific sector with relatively little research into individual institutional performance.