ETF Watch: First Trust Adds 2 Closed End Funds

First Trust, the sixth-largest ETF issuer in the country, with $37.5 billion in assets under management spread across some 112 ETFs, launched two new strategies this week built around closed-end funds (CEFs).

The First Trust CEF Income Opportunity ETF (FCEF) and the First Trust Municipal CEF Income Opportunity ETF (MCEF) are both actively managed ETFs designed to offer investors current income. CEFs are popular with investors for the relatively high income they are known to deliver.

CEFs share similarities with mutual funds and ETFs, but they aren’t exactly like either. CEFs don’t have a daily creation/redemption mechanism, but they have a net asset value, and they trade throughout the day like an ETF.

These traits are sources of risk associated with CEFs, but also one reason CEFs can deliver high income. CEFs often trade at premiums or discounts to net asset value because arbitragers in the market can’t turn to the creation/redemption system to keep the market price linked to fair value. That’s where a lot of the opportunity to capture income lies—if the strategies focus on CEFs trading at deep discounts and are bound to see price appreciation.

Leverage Risk Potential

Another risk associated with CEFs is exposure to leverage.

“Closed-End Funds may utilize leverage. As a result, the Fund may be exposed indirectly to leverage through an investment in such securities,” the prospectus said.

The portfolio managers for FCEF and MCEF will use a “systemic approach to investing,” relying on models centered on economic factors and metrics—things like duration, leverage ratio, average maturity, earnings rate, distribution rate, etc.—to pick and rank CEFs in which to invest. The managers may also invest in ETFs at times.

In the case of FCEF, the portfolio could include exposure to various funds that own equities, U.S. and foreign government debt, corporate debt, muni bonds, commodities, preferred securities, convertible securities, high-yield securities, master limited partnerships and senior loans, according to the prospectus.

FCEF has a management fee of 0.85%, but once costs associated with acquiring underlying funds are taken into account, the costs to own this fund jump to 2.54%, or $254 per $10,000 invested.

MCEF, meanwhile, will focus on municipal bonds. The ETF invests in CEFs that own muni bonds, “some or all of which pay interest that is exempt from regular federal income taxes,” according to the filing.

MCEF has a management fee of 0.75%, and an all-in cost of 1.98%, or $198 per $10,000 invested.

Both funds will launch on Nasdaq.

Other ETFs competing in this space include the PowerShares CEF Income Composite Portfolio (PCEF), the VanEck Vectors CEF Municipal Income ETF (XMPT) and the YieldShares High Income ETF (YYY).

Contact Cinthia Murphy at [email protected]