Closed-end funds may use leverage to potentially enhance portfolio returns over the long term. By borrowing capital, the fund managers seek to provide outsized gains or enhance earnings. The principle is simple: the fund borrows capital or issues preferred shares in order to leverage its portfolio. If the markets are rising and the cost of borrowing is lower than the net long-term rates earned by the underlying fund's portfolio, the fund's common shareholders will see greater returns.
Of course, if the cost of leverage is too high or the markets retrench, it can result in lower returns and increased volatility. Where leverage is used, the NAV will be more volatile than those of comparable unleveraged funds, since the increases or decreases in the total portfolio value are all attributed to the common shares.