The bear market in bonds has been brutal this year, and especially so for certain types of funds that invest in fixed-income securities. But that pain could translate into more-attractive valuations and future returns.

In particular, closed-end bond funds have suffered a triple whammy. Since bond prices decline as yields rise, the value of their holdings has fallen. Most closed-end funds use leverage, that is, borrowed money, to boost their returns. So, the Federal Reserve's increase in its policy interest rate has lifted the cost of those borrowings.

Then there is the matter of their unique structure. Closed-end funds issue a set number of shares, which trade like stocks. Their share price may track the funds' underlying net asset value but can diverge from that significantly. More often than not, CEFs fall to discounts from their NAVs. On occasion, they may command a premium, which may not be warranted.

In either case, the discounts or premiums reflect the inefficient nature of the market for CEFs. Many are small, illiquid, or both, which limits the ability of most institutional investors (other than a small band of activist funds) to take advantage.

Now, however, discounts have widened substantially. And for some formerly high-price CEFs, the premiums have fallen to discounts, making them significantly more attractive for purchase.

Discounts on taxable closed-end bond funds as of Sept. 30 were larger than in 96% of month-end readings since 2015, according to data compiled by Matisse Capital, which manages portfolios of CEFs. Discounts were wider only at the end of December 2007 and September 2008 -- early months of the financial crisis -- and June and November of 2015, when markets began to anticipate the Fed lifting its policy rate from near zero later that year.

The average discount on taxable bond CEFs at the end of September was 9.73%, nearly twice the 20-year average, Matisse found. Of the 107 such funds, nearly half, or 53, traded at double-digit discounts at month end, more than triple the norm.

These are strictly month-end snapshots, noted Eric Boughton, investment strategist and portfolio manager at Matisse, in an interview. Discounts got even wider during the near meltdown of markets in mid-March 2020, during the worst of the pandemic crisis.

The current deep discounts imply that investors are fearful of rising defaults, the increasing cost of leverage, and the rise in yields that has resulted in the declining value of their bondholdings. But investors may have overreacted to such fear factors. "If history serves as a precedent, these factors should reverse in three to six months," Boughton says.

What caught my eye were a variety of CEFs that had seen their previous wide premiums disappear in this year's selloff. That these select funds had continued to command big premiums had been a bit of a mystery. Why would someone effectively pay more than $1.20 for a dollar's worth of assets?

That question has gone unanswered for years. Decades ago, Benjamin Graham referred to closed-end funds as an "expensive monument erected to the inertia and stupidity of stockholders," as Nobel laureate Richard Thaler related in Misbehaving: The Making of Behavioral Economics.

This year's bond bear market has corrected the apparent mispricing of a group of big bond CEFs with previously persistent premiums. Perusing this cohort, I found that some have gone to discounts while eking out a positive total return based on their underlying net asset values. Their respective total returns compared with the 0.18% year-to-date total return from the iShares iBoxx $ High Yield Corporate Bond exchange-traded fund, which closely tracks its NAV owing to the more efficient ETF structure.

The funds listed here have experienced substantial share price declines. Much of that has corrected their previous premium valuations to discounts now. But they continue to generate positive returns on their net asset values. For example, the Pimco Dynamic Income fund has traded at a premium for most of its history since its initial public offering in 2012. Over the past year, however, the $6.8 billion CEF has gone from a premium as high as 16.77% to a discount in the 5% range. Its returns on its underlying assets, meanwhile, remain positive.

That CEF has attracted the notice of none other than Bill Gross, the onetime Bond King and co-founder of Pimco. In an essay on his website titled "Don't Own Bonds and Be Cautious With Stocks," he wrote he would take a flier on the Pimco Dynamic Income fund, owing to its 18% yield and its veteran managers, Josh Anderson and Alfred Murata. Gross also liked the Nuveen Preferred & Income Opportunities CEF, which has fallen to nearly a double-digit discount with a distribution yield over 11%.

It's curious how many Pimco CEFs listed here had previously commanded significant premiums. Those were possibly a reflection of the Newport Beach, Calif.-based firm's estimable reputation, especially among individual investors, who constitute the bulk of CEF holders. Also, based on an unscientific sampling of my reader emails, owners of such funds have said they didn't care about overvaluation since they were enjoying hefty income returns and were sitting on gains. Those gains may have dissipated in this year's decline.

That brings up another point about closed-end bond funds and bonds in general. Many investors are likely to be doing tax swaps this year, selling holdings that have declined and buying other depressed issues, thus sharing their losses with the taxman. Selling to establish tax losses may keep these CEFs under pressure in coming weeks. But those declines may also offer opportunities.