If you’re hoping to generate income from your investment portfolio, closed-end funds could be one piece of the puzzle.

These funds come with more risk than, say, U.S. Treasurys, yet also can provide decent yields that may have a place in the fixed-income portion of your investment portfolio. And sometimes, they give you a way to invest in the underlying stocks or bonds at a price lower than if you were by them on the open market.

However, experts say it’s important to understand what you’re buying.

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As of Jan. 31, there were more than 500 closed-end funds, with assets totaling $296 billion, according to Morningstar Direct. By comparison, mutual funds have roughly $24.3 trillion in assets.

Unlike traditional mutual funds, however, closed-end funds generally issue a set number of shares at their creation — similar to a company that goes public — and trade on the open market like a stock. This means that while the share price might be related to the performance of the fund’s underlying assets, it is based on investor supply and demand. 

Thus, closed-end fund shares can routinely trade at a discount, or below their so-called net asset value (the bottom-line value of the fund’s assets divided by the number of outstanding shares). Or, they can trade at a premium (above that NAV).

“For fixed income funds, we’re seeing a little better returns … sometimes because they are at a discount, anywhere from 3% to 10% of NAV,” said certified financial planner Robert Finley, principal at Virtue Asset Management in Chicago.

“From our point of view, that provides some protection in a rising-rate environment,” Finley said.

For funds invested in equities, he said, discounts to NAV can appear in areas of the market that have been sold off and are now undervalued.

“When the overall market tends to have a pullback, closed-end funds tend to get oversold,” Finley said. “So we’ll look through and see if there are any specific areas discounted.”

Closed end funds also are actively managed — meaning experts are at the helm picking the underlying investments, whether stocks, bonds or other investments. And, many generate income that’s distributed on a monthly or quarterly basis. Most assets (62%) in closed-end funds are invested in bonds, according to the Investment Company Institute.

Additionally, these funds also may put their assets in less-liquid investments, such as very small companies, municipal bonds that aren’t widely traded or emerging market securities.

Many closed-end funds use leverage, subject to regulatory limits, to juice their returns. That is, they can borrow money to invest. However, leverage also means that losses can also be exacerbated (if you sell).

Closed-end funds are generally volatile, Finley said. “People should be aware that when the market pulls back or has a major move, these funds move more.”

The cost depends on the fund itself and its specifics. Generally, you might pay anywhere from about 0.75% of assets in the fund to 2% or higher, especially for funds that employ leverage in their investment strategy, Finley said.

As for yields, it depends on the underlying assets. For instance, for those invested primarily in federally backed mortgages, the yields are roughly 3% to 5%, Finley said. For those that invest in certain corporate debt with variable rates, yields are 5% to 7%, he said.

And of course, there’s no guarantee that any given fund or mix of funds will outperform (or be in the black). In the fixed-income side of your portfolio, it’s probably worth having no more than 15% of your assets in closed-end funds, Finley said.