High Yields Aren't Always a Good Thing

By JASON ZWEIG


In the parched landscape of income investing, dozens of closed-end funds yield more than 10%.

Just as wanderers in the desert shouldn't mistake a mirage for an oasis, investors shouldn't regard these funds as salvation. Often, the income you earn in the short run mightn't be worth the principal you lose in the long run.

Like mutual funds, closed-ends are baskets of stocks or bonds. Unlike a mutual fund, a closed-end trades like a stock; you can buy shares only from other investors. Thus the price isn't set merely by the value of a closed-end's investments, but by the whims of those who trade its shares. When investors pay more than the portfolio's net asset value, that is called a "premium." When the shares trade at less than NAV, that is a "discount."



As of last week, 11 of the roughly 650 closed-ends tracked by Lipper Inc. traded for at least 20% more than their portfolios are worth. In many cases, investors are paying those big premiums in pursuit of high yields.



Buy such a fund, and you may double-dose on risk. A yield that looks stable can crumble; then the premium may collapse as panicked investors dump the fund. That leaves you with less income than you expected—and a big market loss to boot.



Look at Dow 30 Enhanced Premium & Income, which paid out 16.7 cents per share monthly in 2009. At year end, the fund dropped its dividend to 8.5 cents, without explanation. The shares collapsed from nearly a 30% premium to a 3% discount. Investors are left with their income halved on a share price cut by one-third. The manager, IQ Investment Advisors, declined to comment.



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Some yields may just be unsustainable. Pimco Global StocksPLUS & Income, recently at a 63% premium, yields 19.6% on its underlying assets, according to Lipper. That's as much as five times the yield on the StocksPLUS open-end funds that Pimco also runs. Another closed-end, Pimco High Income, out-yields a related open-end fund, Pimco High Yield, by 2 to 1. (Open-end funds customarily report yields that count income only.)



Citing Securities and Exchange Commission rules on disclosure, Pimco declined to comment on yield policy. Pimco Global StocksPLUS jacks up yield partly through borrowings. Also, some of its yield seems to be return of capital, although that won't be finalized for tax purposes until the fund's fiscal year ends next month.



Gabelli Utility Trust, recently at a 60% premium, has paid out at least six cents per share every month since late 2001. Back in 2007, two-thirds came from dividends and capital gains on the fund's investments. Over the past year, however, 90% of the yield has been return of capital. "One could argue about whether that's good or bad," says manager Mario Gabelli, "but I personally think the premium is unsustainable. It's off the wall."



Investors like Benjamin Graham and Warren Buffett got rich buying a dollar's worth of assets for 60 cents. But when you pay a 60% premium for a closed-end, each dollar of capital returned to you as "yield" effectively has cost you $1.60. For a clearer picture, look up the fund's "income-only yield" on www.cefa.com. Then, advises veteran closed-end analyst Mariana Bush of Wells Fargo Advisors, make sure it isn't much higher than the yield on a similar open-end or exchange-traded fund. Most high yields turn out to be just a mirage.



Write to Jason Zweig at intelligentinvestor@wsj.com