Most people don’t realize this, but there’s a simple, two-step way to grab serious gains in high-yield closed-end funds (CEFs).

I call it the Index Boomerang Effect. And when I say it’s simple, I’m not kidding around.

It goes like this: over time, we can expect a CEF in a particular asset class to perform around as well as the index that represents it (though to be honest, the best CEFs tend to beat their indexes handily, which makes our strategy even more powerful).

But even the best CEFs do lag their indexes from time to time. The key is to spot those times and buy—then ride your CEF to strong gains as the index “pulls” its share price higher.

That’s step 1.

Step 2 comes in when you boost your CEF’s index-generated gains with a nice discount to net asset value (NAV, or the value of a CEF’s underlying portfolio). That’s an easy metric to spot on any CEF screener.

That’s it. Literally two steps to scoring big gains to go along with CEFs’ dividend payouts, whose yields regularly run above 7%.

Our Index Boomerang Effect in Action

Let’s put our strategy in play with a corporate-bond CEF called the Invesco Bond Fund (VBF), which closely resembles the CEF Insider Taxable Bond Index. This index is part of our CEF Insider Index Tracker, which makes our plan even simpler because it lets us instantly compare a CEF to the performance of its index (and other CEFs, too).

The CEF Insider Taxable Bond Sub-Index is going strong in 2021, with a nice 8.5% return so far.

Index Soars in ’21 …

While most corporate-bond CEFs are following this trendline, some aren’t, including black-sheep VBF, which has seen its total return (based on market price) slide 7.6%.

Is this a sell signal? No way! It’s a sign that now would be a good time to buy VBF.

That’s because, when we stretch our view out to a decade, we see that VBF’s 95% total return is about a third above that of the broader high-yield bond market.

In other words, this recent lagging performance is an anomaly. And our Index Boomerang Effect is powering up to reverse the short-term dip in VBF we’ve seen this year.

Here’s where the discount to NAV comes in, because the decline VBF’s market price has posted in 2021 stems from emotion-driven investors selling the fund, not management’s performance. On a NAV basis (or as measured by the value of its portfolio), VBF is flat for 2021.

This disconnect has caused the fund’s discount to fall steadily in the last couple of months.

What we’re seeing here is typical of CEFs. In volatile times, a fund can see a selloff on the open market while its portfolio doesn’t budge, resulting in a discount we can take advantage of. And buying CEFs at the right time is crucial. Let’s look at what investors who bought in December 2011, when VBF was trading at a 9.9% premium to NAV, saw next…

Two years of zero profits, while the typically underperforming index returned 20%!

Now look at investors who bought in February 2012, just a little over a month later, when VBF traded at a 3% discount … outperformance!

This trick doesn’t just work for VBF; it’s a time-tested method of extracting profits from the inefficient CEF market. This is because, over the long haul, CEFs will inevitably return to, or exceed, a trendline similar to the index they represent, especially if the CEF has been underperforming that trendline due to a widening discount to NAV.

And we’re seeing this happen not just with VBF, but with over a hundred CEFs of the 500 or so on the market today. That gives us plenty of opportunity to amplify our profits, lock in long-term income and buy at discounts, even when the market is heating up.

Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 8.3% Dividends.”

Disclosure: none