Watch the Closed End Fund Leverage

A number of folks pointed out the rising costs of leverage used by Closed End Funds (CEFs).  It seems reasonable to warn that investors could get a bit of a surprise  with these distributions if short term interest rates rise too much.  Most all income related CEFs use leverage of 20-35% and they finance the leverage in many ways, but even if they are using very short term repo’s (repurchase agreements) their interest costs are much higher than they were a year ago.

Bea pointed out the increasing costs for the Invesco High Income 2023 Target Trust (IHIT) which finances their leverage with a $80 million repurchase agreement.  The fund has paid about $400,000 more in interest during the 6 month period as compared to last year as the interest rate was 3.38% during the most recent period as compared to about 1% less last year.  This matters!  How much it matters is really unknown as many of the securities they invest in are floating rate–so how things all fall out is not very predictable.

In the case of the IHIT Term Trust investors should keep their positions reasonable in size.  If we are to assume the Trust has no defaults on holdings investors will be ‘made whole’ (or $9.835/share) so to speak in 2023—BUT in the mean time there could be minor distribution reductions which, at this point in time, would knock the share price down from the $10 area.  There is interest rate risk–and it will remain until maybe 18 months (a guess) prior to ‘maturity’ (liquidation).

Because of leverage we seldom have owned CEFs with the exception of IHIT–leverage cuts both ways–great in a rising market and doubly bad in a falling market so we are just passing on some warnings from readers–some very smart folks.