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. How are blue-chip stocks similar to mutual funds and exchange-traded funds (ETFs)?

    Understand the primary differences between making investments in blue-chip stocks, mutual funds and exchange-traded funds ...
  2. What are some of the most popular mutual funds for investing in the metals and mining ...

    Explore some of the many mutual fund options available to investors that focus on holdings in the metals and mining sector, ...
  3. What are the most popular mutual funds that give exposure to the forest products ...

    Investing in the forest industry has become an attractive choice for portfolio diversification among a wide range of mutual ...
  4. What are the most popular mutual funds that give exposure to the railroads sector?

    Investing in sector-specific mutual funds, such as transportation funds that include railroad company stock, can be a smart ...
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 ...

You May Also Like

Related Articles
  1. Stock Analysis

    Why This Bond Fund Should Be in Your ...

  2. Stock Analysis

    Is PIMCO's Commodity Strategy (PCRDX) ...

  3. Stock Analysis

    Time to Look at PIMCO's Total Return ...

  4. Economics

    Gary Gordon Positions Your Portfolio ...

  5. Professionals

    A Look At Pimco's Total Return Fund ...

Trading Center