Closed-End Funds

Understanding Discounts and Premiums

Similar to other publicly traded securities, the share price of a closed-end fund fluctuates and is generally determined by supply and demand forces in the marketplace. As a result, the price at which investors buy and sell closed-end funds shares in the secondary market may differ from the fund's NAV, thereby creating discrepancies between NAV and share price—or, in other words, a premium or discount.

A closed-end fund's NAV represents the market value of all securities owned by the portfolio plus all other assets, minus liabilities and divided by the total number of shares outstanding. The share price of a closed-end fund may, at any time, be above (selling at a premium) or below (selling at a discount) its NAV. For example, if the price of a fund share is $18 and its NAV is $20, then the closed-end fund is selling at a discount of $2 per share (or 10% discount). On the other hand, if the share price is $21, the closed-end fund is selling at a premium of $1 (or 5% premium).

There are numerous factors that contribute to how a closed-end fund trades. Thus, a particular closed-end fund's trading pattern is not always easily explained.

Why Does a Closed-End Fund Trade at a Discount or Premium?

Closed-end funds are subject to the laws of supply and demand in an open market. Likewise, the factors that affect how a closed-end fund trades, and ultimately the factors that determine whether a fund trades at a premium or discount, are factor s that influence an investor's demand for a fund, such as:

• Current yield on stock price/NAV (relative to other closed-end funds/investment products)
• Current discount/premium
• Dividend cuts/increases
• Fund performance (relative to other closed-end funds/ investment products)
• Performance of the closed-end fund's sector (relative to other closed-end funds /investment products)
• Investor sentiment
• Market outlook
• Sector outlook
• Availability of comparable products

Looking at Closed-End Funds Trading at a Discount

A closed-end fund trading at a discount simply means that you can purchase assets at a price that is less than their current market value. For example, a fund trading at a 20% discount from NAV would give an investor $1.00's worth of underlying assets for $0.80. An investor who takes advantage of this potential opportunity hopes that at some point in the future a fund's market price will trade closer to its NAV.*

A fund's ability to generate distributions is based upon the earnings power of a fund's underlying assets, and fluctuation in market price of fund shares has no bearing on a fund's distribution. Therefore, if a fund's distribution remains steady and a fund's market price falls from its NAV, the yield that the prospective investor receives is higher; essentially, the investor is paying less for the same amount of distribution. On the other hand, as discounts narrow investors pay more to access a fund's distribution, resulting in a lower yield based on
current market price.

A fund selling at a discount may have greater yield than a similar investment priced at NAV. Investors attempting to get the same yield from investments priced at NAV may have to increase their implicit investment risk appetite.

It is also important to note that discounts do not always represent a value opportunity. A fund may be trading at a discount because the market has determined that its future earning or distribution potential is limited or because the fund is paying a dividend that is lower than the average dividend paid by its peer group. There may be significant cash flow deficiencies in a fund (i.e., deterioration of NAV) and these factors may be reflected in a discounted market price. There is also no guarantee that any discount will narrow or that a fund's NAV will not fluctuate.

*Note: Long-term investors who own a closed-end fund for the income it generates through fund distributions may, from a purely objective point of view, have little or no concern for the fund's current discount/premium to NAV. However, investors are typically very interested in the value of their assets. So, even for income-oriented investors who have no desire to sell shares, there still exists considerable motivation to see share prices increase.

Closed-End Fund Trading at a Discount

As illustrated in the hypothetical example below, when a closed-end fund trades at a discount, its market price is lower than its NAV.

Looking at Closed-End Funds Trading at a Premium

The reasons why a closed-end fund may trade at a premium are just as varied as why it may trade at a discount. A fund trading at a premium may be an indication of effective portfolio management performance, may reflect a fund's perceived ability to sustain its dividend payout over the long term or may be the result of capital appreciation in the NAV that warrants, in the opinion of prospective investors, a premium to its current value.

If a fund performs well or exhibits strong cash flow fundamentals, the market may make recognition of that fact through an increase in share price. A closed-end fund trading at a premium may be attractive to an investor who believes that the share price may continue to appreciate. If the fund utilizes leverage, the investor may also see an opportunity to obtain a higher yield when compared to other similar investments and be willing to purchase the fund at a premium. It may also be the case that there are few, if any, comparable funds offered in the category or sector, which may result in a fund trading at a premium to its NAV due to the associated supply/demand effect.

Another important consideration is that a fund may be providing a strong (or high) level of dividend distributions. If a closed-end fund is paying high dividends, the market demand for these distributions may increase the share price. The market prices for many closed-end funds are closely correlated to fund distribution levels, relative to peers.

However, a closed-end fund trading at a premium may also be simply overvalued. For example, a closed-end fund may be paying high dividends, but those dividends may be unsustainable. If a fund is paying dividends at a greater rate than it is earning, the long-term performance of the fund may be at risk. It may also be the case that depreciation in the fund's NAV has not been appropriately reflected in the stock price.

Closed-End Fund Trading at a Premium

As illustrated in the hypothetical example below, when a closed-end fund trades at a premium, its market price is higher than its NAV.

Finding the Value in Discounts and Premiums

During any period of time, a closed-end fund's market price may be at, above or below its NAV. As we have seen, there are a variety of reasons why a closed-end fund may trade at a discount or premium. Prior to investing, an investor should meet with a financial advisor to assess a closed-end fund's trading history, performance and overall value in relation to the investor's own investment objectives.

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This material is for educational purposes only and is not to be construed as a solicitation or an offer to buy or sell securities. The views expressed are those of BlackRock, and the information contained is not necessarily all-inclusive. Reliance upon information in this guide is at the sole discretion of the reader. Past performance does not guarantee future results. No assurance can be given that a fund will achieve its investment objective. The investment return and principal value of an investment will fluctuate, so that an investor's shares, when sold or redeemed, may be worth more or less than their original cost.

Leverage cannot assure a higher yield or return to the holders of a closed-end fund's common shares. Leverage can be a source of increased volatility and greater risk.

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