Opportunities for Gains in 2009: CEF Year-End Muni Discounts

Includes: MHN, MUC, MUJ, MYN, VPV
by: Joe Eqcome

Conclusion: There has been a historical inverse relationship between a closed end fund’s [CEF] beginning year discount and its year-end price change, i.e., the greater a CEF’s discount at the beginning of the year the greater the relative positive price change at year-end relative to other CEFs. This relationship proved uniquely strong for the Muni Sub-Index in 2008. As we prepare to embark into 2009, here are 5 Muni CEFs in the Muni Sub-Index with the greatest discounts at the end of 2008: MHN, MUJ, VPV, MYN and MUC (see summary table at end). To paraphrase Mark Twain, “History may not repeat itself, but it sure does rhyme.”

The muni markets may also benefit from the stabilization in the credit markets as well as the federal fiscal stimulus plan(s) that may include supporting state and local governments’ debt either through a federal lending facility or government guarantee programs for municipal debt. This would likely narrow the yield spread between munis and treasuries from its current historic highs. Such a narrowing of spreads could lead to a significant upward revaluation of the municipal securities.

click to enlarge

Beginning Year Discounts Vs Year-End Price Changes: The first table above illustrates the premium/discount for the CEFs comprising the Muni Sub-Index at the beginning of 2008 (year-end 2007) with their relative price changes at year-end. Below that table is a scatter diagram of the data. As the chart demonstrates there appears to be a visible relationship between the two variables. (The R^2 for the Muni Sub Index is 0.3753; approximately 38% of the price change can be associated with the level of the discount.) This is in contrast to the R^2 of the Aggregate Index of 130 CEFs comprising the Index which was minuscule for 2008; the relationship appeared almost random.

Deep Discount Muni CEFs: Below is a list of the top 5 heaviest discounted Muni CEFs at the end of 2008 in the Muni Sub-Index. The historic spread in the muni markets may narrow as the credit markets stabilize and the federal government fiscal policy may facilitate the support of municipal debt markets. Keep in mind that the muni CEFs in the chart below are all leveraged with auction rate preferred shares that are subject to regulatory leverage requirements which if breached could lead to a temporary suspension of the dividends.

Disclosure: Joe Eqcome is long MHN.