There are investments most people know about...
And then there are investments everyone should know about, but don't for some reason...
Warning: Seniors In BIG Trouble
Take mutual funds.
Mutual funds are pooled investments managed by a professional investor or team. They target a particular sector, industry, index, or have another well-defined focus.
There are actively-managed mutual funds -- which buy and sell investments to beat some particular benchmark.
There are also passively-managed funds which aim to match a given index's performance.
Most people know about these kinds of mutual funds...
But I'm willing to bet most investors DON'T know about a special type of mutual fund called a "CEF".
Even fewer realize the advantages these CEF’s can provide.
CEF stands for "Closed-end fund."
Like regular mutual funds -- which are technically known as open-end funds -- closed-end funds are pooled investment portfolios run by a manager or managers.
And like open-end mutual funds, CEFs have to focus on something well-defined -- targeting a particular sector or industry, for example.
But unlike regular mutual funds, CEFs trade like stocks with values that fluctuate throughout any given trading day.
In this way, they are actually more similar to exchange-traded funds (ETFs).
One thing to remember is that since CEFs are basically mutual funds trading as stocks, closed-end funds will cost you brokerage commissions PLUS ongoing annual management fees.
Of course, some managers are certainly worth those higher fees...
In fact, closed-end funds can give you access to rockstar managers that are otherwise only available to extremely wealthy clients.
However, you should always look for lower expenses when all other things are basically equal. You can find this information on most major websites or get it from the fund families themselves.
Closed-end funds also tend to have a greater focus on producing outsized income. Many invest in bonds and preferred shares as well as common stocks.
While I consider that to be a benefit, it does create a tax wrinkle that you should be aware of...
Income derived from bonds and preferred shares is treated as ordinary income and taxed that way rather than the lower rate applied to qualified dividend payments. If you invest in a tax-sheltered account like an IRA, however, then this is a moot point.
It's always good to look for closed-end funds that have relatively long histories of operating, preferably under the same management team. That will give you a better read on how the fund performs over time and through various market conditions. It will also help you gauge how the ebbs and flows of investor interest have affected the fund's price swings.
That brings me to the most unique feature of closed-end funds...
They can trade at discounts or premiums to the value of the underlying assets they hold (known as the net asset value, or NAV).
The gap is simply a function of supply and demand for the fund on that particular day. It happens because closed-end funds only issue a certain number of shares rather than an unlimited number like regular mutual funds.
It's where the terminology "closed" vs. "open" comes from in the first place. (There is also such a thing as a "closed" open-end fund... but that simply means that it is no longer accepting new investors.)
Quite often you'll find that closed-end funds trade at some well-defined historical discount to their NAV. That general gauge can serve as a good first indicator of when it might be an opportune time to buy in.
In other words, you can end up getting a great deal on a CEF if you buy it at a nice discount to its NAV.
If the gap eventually narrows, you'll earn an extra profit.
Some hedge fund managers and other sharp investors have actually developed entire strategies around this idea.
And now, in a strange twist, a relatively new exchange-traded fund actually aims to do it for you.
It's called the Saba Interest Rate Hedged CEF ETF (NYSE: CEFS), and it was developed by a well-known hedge fund manager named Boaz Weinstein.
Mr. Weinstein got famous in the world of finance for taking down "the whale of London" a few years back. The quick explanation is that he took the opposite side of a massive trade coming from a desk at J.P. Morgan. He turned out to be right and J.P. Morgan ended up losing $2 billion.
More recently, Mr. Weinstein has been targeting various closed-end funds with his hedge fund. And he's gotten so good at it, that some people say he has single-handedly caused a narrowing of NAV discounts in general.
Still, opportunities remain. So much so that Weinstein has launched that novel ETF for regular investors.
It's fairly new and doesn't trade high volumes. But the idea of a hedge fund manager... targeting closed-end funds... through an exchange-traded fund is definitely interesting and I'll be looking into it further.
This article originally appeared on The Daily Reckoning.