Closed-end funds have become popular in recent years as bond yields have dropped precipitously. As a result, income investors have gone further out on the yield curve to find the kind of yields with CEFs they used to enjoy in the days when bonds were offering higher interest payments.
One of the things my stock advisory newsletter, The Liberty Portfolio, does is find securities that deliver better risk-adjusted returns than you’ll find in the market. This is not an easy task because most investors don’t realize just how much risk they are taking on so-called “safe investments,” even with CEFs.
This is not an easy task because most investors don’t realize just how much risk they are taking on so-called “safe investments,” even with CEFs.
Today, I’m looking at three tax-free municipal bond CEFs as possible starting points for investors to consider adding to the portfolio. They aren’t quite up to the standards of The Liberty Portfolio, but they have many strong attributes.
High-Yield Closed-End Funds: BlackRock Municipal Bond Trust (BBK)
Tax-Equivalent Yield: 8.55%
BlackRock Municipal Bond Trust (NYSE:BBK) is a decent candidate for more aggressive investors, although it has pieces that I’m not crazy about. BBK invests in municipal bonds that are tax-exempt for federal income tax purposes.
It has a ten-year annual average total return of 7.26%. For those in the highest tax bracket, that’s equivalent to a whopping 12% yield. However, it has an expense ratio of 1.77%.
More than 71% of the bonds are A-rated or better. However, it carries bonds from Illinois and New Jersey, the two bottom feeders in the Mercatus Center’s ranking of states with the worst fiscal situations.
Because less than 8% of the entire portfolio is insured, you might want to either comb through the holdings to see just how much exposure there is to state-level bonds, or short a corresponding security for those states, if you can find them.
High-Yield Closed-End Funds: Western Asset Municipal Partners Fund (MNP)
Tax-Equivalent Yield: 8.36%
Western Asset Municipal Partners Fund Inc. (NYSE:MNP) has a few things going for and against it. MNP is like most municipal bond tax-free funds in that also has carried muni bonds from states that aren’t in great shape.
This is the problem with the best performers, because they have bonds from the shakiest states, and therefore those that pay higher rates. Still, A-rated and higher bonds represent more than 80% of the portfolio. There are bonds from the bottom three states accounting for about 11% of assets – although that’s why this CEF trades at a 4% discount to NAV.
MNP has a ten-year annual average total return is 6.72% with a total expense ratio of 1.61%. Now, you may ask why these CEFs have such high expense ratios. Well, it’s because most are leveraged. Which means that they borrow money to turn around and buy bonds.
So they are able to boost returns by borrowing money at a lower rate than the bonds pay. Hence, most carry about 50 bps to 60bps of interest expense on the loans.
High-Yield Closed-End Funds: Nuveen Texas Quality Municipal Income Fund (NTX)
Tax Equivalent Yield: 7.79%
If you want to stick with muni bonds from Texas, the 23rd highest-rated state according to Mercatus, consider Nuveen Texas Quality Municipal Income Fund (NYSE:NTX).
The ten-year average annual total return is 5.82%. In this CEF, we have over 87% of the assets A-rated or higher. Hence, the lower returns. Not only that, while most funds have about 150 holdings across several states, this has 148 holdings over just Texas. So it has its money in many different municipalities.
NTX trades at a 6.3% discount to NAV, which I think overestimates the possibility of default in some of these municipalities. It has a lower expense ratio of 1.28%, and in this case, 0.59% comes from that interest expense that I mentioned.
It, too, is leveraged at about 31% — roughly the same as most of the muni bond CEFs on the market.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at [email protected].