Why do closed-end funds issue preferred stock?
Issuing preferred stock allows a closed-end fund to raise additional capital, which it can use to buy more securities for its portfolio. This strategy, known as leveraging, is intended to allow the fund to produce higher returns for its common shareholders over the long-term. Funds can also leverage by borrowing money or issuing debt securities. In addition to this structural leverage, some funds may employ other economic forms of leverage through certain types of investment transactions (e.g., reverse repurchase agreements, derivatives, tender option bonds). Funds invest the additional capital raised through leverage in securities that are expected to earn a rate of return that exceeds the short-term borrowing cost of the preferred stock or other leveraging instrument. The additional income, or return, is then available for the benefit of common shareholders.
