The Dual-Purpose Fund: An Overview

A dual-purpose fund is a closed-end fund that holds both common shares and preferred stock shares. Investors in such funds seek the best of both worlds:

  • Common stock shares are generally chosen by investors seeking growth in the value of their shares over time. They may or may not pay dividends to their shareholders.
  • Preferred shares are for investors who want the regular dividend payments that these shares guarantee. This type of stock usually holds its value but does not increase much in price.

Dual-purpose funds fell out of favor in the late 1980s when tax rules made them unattractive compared to other types of funds.

Key Takeaways

  • Dual-purpose funds are, or were, investments that held both common stock and preferred shares.
  • They lost favor in the late 1980s after losing their tax advantages.
  • Dual-purpose funds are closed-end funds that trade on an exchange throughout the day.

Understanding the Dual-Purpose Fund

Dual-purpose funds might more accurately be called split-purpose funds. Most stock investors focus either on price growth or regular income. They are either risk-tolerant or risk-averse. An investor can be somewhere in the middle, but nobody can be both at the same time. Dual-purpose funds tried to serve both goals at once.

Dual-purpose funds were popular in the late 1970s and early 1980s. Today's investors have a much wider range of mutual funds, exchange-traded funds (ETFs), and other investment options to choose from.

There are still many closed-end funds. These, by definition, are issued in a fixed number of shares that are set to expire at a fixed date.

How a Closed-End Fund Works

Closed-end funds, like exchange-traded funds (ETFs), have ticker symbols and trade throughout the day on a public exchange.

In most other respects, they are similar to mutual funds from the viewpoint of the investor. They sell shares in a portfolio of securities run by an active manager. Most are designed to exploit opportunities in specific industry sectors, regions, or markets. Most can be characterized by their investment style and the degree of risk they tolerate, from conservative to highly aggressive. They also charge an annual expense ratio and make income and capital gain distributions to their shareholders.

Open and Closed

However, open-end mutual funds, by far the most common type, price only once at the end of the day. Closed-end funds trade throughout the day.

Closed-end funds require a brokerage account to buy and sell, unlike most open-end funds.

The stock prices of all closed-end funds fluctuate based on supply and demand for the fund itself as well as the changing values of the fund holdings. Exchanges publish the net asset value (NAV) of the funds regularly.

However, closed-end funds often trade at a premium or a discount to NAV. The reputation of the fund’s manager as a stockpicker and the popularity of the underlying holdings help determine this discount or premium.

A downside to closed-end funds is that they can be fairly illiquid. That is, their shares might not be available in sufficient volume to ensure that a seller can get out of the investment quickly without the risk of a substantial loss.

One of the largest and most liquid closed-end funds is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund.

Dual-Purpose Funds vs. Strips

The common shares of dual-income funds have a parallel in the fixed income investment known as Treasury STRIPS. These zero-coupon bonds separate the bond’s coupons from the bond or note. An investor's return depends on the difference between the purchase price and the bond's trading value, or face value if it is held to maturity. Thus, income has no bearing on return.

Similarly, common shares of dual-income funds strip out the income portion of the return. This payment stream is sold separately and is accessed by buying the preferred shares.