What is "leverage" as it is used in closed-end funds?

By Steven Merkel AAA
A:

A distinguishing feature of closed-end funds is their ability to use borrowing as a method to leverage their assets. An ideal opportunity exists for closed-end equity and bond funds to increase expected returns by leveraging their assets by borrowing during a low interest rate environment and reinvesting in longer-term securities that pay higher rates.
In low interest rate environments, closed-end funds will typically make an increased use of leverage. This leverage can be used in the form of preferred stock, reverse purchase agreements, dollar rolls, commercial paper, bank loans and notes, to name a few. Leverage is more common in funds that are invested in debt securities although several funds invested in equity securities are also using leverage.

The downside risk of using leverage is that when stock or bond markets go through a market downswing, the required debt service payments will cause returns to shareholders to be lower than those funds not utilizing leverage. In turn, share prices will be more volatile with debt financing or leverage. Also, when interest rate rise, the longer-term securities will fall in value, and the leveraging used will magnify the drop, causing greater losses to investors.

This question was answered by Steven Merkel.

RELATED FAQS

  1. What is the minimum amount of money that I can invest in a mutual fund?

    Learn about investing in mutual funds even with a smaller initial investment; there are many funds available to investors ...
  2. What does a mutual fund's beta coefficient measure?

    Evaluate the risk associated with a particular mutual fund by determining its beta coefficient, which illustrates the fund's ...
  3. How can I get a mutual fund prospectus?

    Read and understand the prospectus before investing in a mutual fund. You can obtain a copy from the fund company, your financial ...
  4. Can I purchase mutual funds for my IRA?

    Learn how to invest your IRA assets in mutual funds. Discover a few of the different types of mutual funds available for ...
RELATED TERMS
  1. Historic Pricing

    A method for calculating the value of an asset using the last ...
  2. Bear Fund

    A mutual fund designed to provide higher returns when the market ...
  3. Ulcer Index - UI

    An indicator developed by Peter G. Martin and Byron B. McCann ...
  4. Investment Company Act Of 1940

    Created in 1940 through an act of Congress, this piece of legislation ...
  5. Product Portfolio

    Investopedia explains: A Product Portfolio is the collection ...
  6. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
Related Articles
  1. How Does Janus's Fund Lineup Look Now?
    Investing Basics

    How Does Janus's Fund Lineup Look Now?

  2. Thank You, Pimco: BlackRock Drops Bond-Fund ...
    Investing Basics

    Thank You, Pimco: BlackRock Drops Bond-Fund ...

  3. What Bill Gross's Arrival Means To Janus ...
    Mutual Funds & ETFs

    What Bill Gross's Arrival Means To Janus ...

  4. The Key Differences Between ETFs And ...
    Investing Basics

    The Key Differences Between ETFs And ...

  5. 5 Things You Need To Know About Index ...
    Investing Basics

    5 Things You Need To Know About Index ...

Trading Center