Unlocking Income Potential: How CEF-to-ETF Swaps Thrive in 2025's Rising Rate Climate

In July 2025, the closed-end fund (CEF) market has emerged as a compelling arena for income-focused investors, particularly as rising interest rates and tightening liquidity reshape asset valuations. With CEF discounts narrowing across key sectors—equity CEFs at -6.2%, municipal bond funds at -6.4%, and BDCs at -5.5%—the stage is set for strategic arbitrage opportunities. ETFs like the Calamos CEF Income & Arbitrage ETF (CCEF) are uniquely positioned to capitalize on these dynamics, offering a dual benefit of high yield and capital appreciation while mitigating liquidity risks.

The Case for CEF-to-ETF Swaps in a Rising Rate Environment

Rising interest rates typically compress bond prices and increase borrowing costs, but CEFs with leverage can amplify returns in such scenarios. For instance, taxable bond CEFs, which average 25.1% leverage, have seen discounts narrow to -0.5% in Q1 2025, reflecting investor confidence in their ability to generate income amid rate hikes. ETFs like CCEF exploit this by investing in CEFs trading at attractive discounts, leveraging their leverage and active management to enhance returns.

CCEF's 8.00% distribution yield and 17.04% total return since inception (as of July 31, 2025) underscore its effectiveness. By holding 46 CEFs across equity, fixed income, and international markets, the ETF diversifies risk while targeting capital appreciation as discounts narrow. This strategy is particularly potent in a rising rate environment, where CEFs with high-yield, leveraged portfolios can outperform traditional ETFs.

Arbitrage Opportunities and Liquidity Advantages

The narrowing CEF discounts create arbitrage potential for ETFs like CCEF. For example, municipal bond funds, which trade at -6.4% discounts, offer yields of 6% with 31.7% leverage, making them attractive for CCEF's portfolio. Meanwhile, BDCs—despite a slight discount widening to -5.5%—still provide robust yields of 10.8% with 51.3% leverage. These metrics highlight how CCEF can selectively target CEFs with the most compelling risk-adjusted returns.

Liquidity is another critical factor. CCEF's 30-day median bid/ask spread of 0.35% (as of August 7, 2025) ensures efficient trading, unlike many traditional CEFs, which often face wider spreads due to lower volumes. This liquidity advantage allows CCEF to execute arbitrage strategies more effectively, capturing price discrepancies between CEFs and their net asset values (NAVs).

Diversification and Active Management in a Shifting Market

The CEF universe's structural diversity—spanning $958 billion in assets across 807 funds—enables ETFs like CCEF to hedge against sector-specific risks. For instance, while equity CEFs face volatility in a rising rate environment, taxable bond and municipal bond CEFs offer stability. CCEF's active management team dynamically allocates capital to the most attractive CEFs, adjusting exposure based on macroeconomic signals and discount trends.

Activist investor activity further enhances this strategy. With $6.0 billion in Q1 2025 targeting CEFs for restructuring or liquidation, ETFs like CCEF can capitalize on short-term price dislocations caused by activist interventions. This proactive approach ensures the fund remains aligned with market-moving trends, such as the Trump administration's tariff policies and Federal Reserve rate decisions.

Strategic Investment Advice for 2025

For investors navigating a rising rate environment, CEF-to-ETF swaps via CCEF offer a compelling solution. Here's how to leverage this strategy:
1. Prioritize Yield and Leverage: Focus on CEFs with high yields and moderate leverage, such as municipal bond funds (6% yield, 31.7% leverage) or BDCs (10.8% yield, 51.3% leverage).
2. Monitor Discount Trends: Track narrowing discounts in sectors like taxable bonds (-0.5%) and municipal bonds (-6.4%) to identify undervalued CEFs.
3. Leverage ETF Liquidity: Use ETFs like CCEF to access CEF exposure with tighter spreads and lower transaction costs compared to direct CEF purchases.
4. Diversify Across Asset Classes: CCEF's 46-holding portfolio spans equities, fixed income, and international markets, reducing sector-specific risks.

Conclusion

As 2025 unfolds, the interplay of rising rates, tightening liquidity, and narrowing CEF discounts creates a fertile ground for income-focused investors. ETFs like CCEF bridge the gap between traditional CEFs and liquid ETFs, offering a strategic blend of high yield, capital appreciation, and active management. By harnessing arbitrage opportunities and leveraging the CEF universe's structural advantages, investors can diversify their portfolios while capturing the upside of a dynamic market. In this environment, CEF-to-ETF swaps are not just a tactical move—they are a cornerstone of resilient, income-driven investing.