Muni Bond Funds Look More Expensive but Demand's Still Strong

Aug.23.09 | About: iShares National (MUB)

With paltry yields on savings accounts, money markets, CDs, and U.S. government debt, investors have flocked to corporate and municipal debt en masse this year in search of higher yields and closed-end municipal bond funds have been no exception.

Now, however, a lot of the bargains are gone and in our MuniFundInvestor.com newsletter, the number of recommended funds with a buy signal has dropped dramatically. What follows is a current snapshot of the closed-end municipal bond fund landscape.

Currently, closed-end national municipal bond funds are delivering yields ranging from 3.5% up to 9.1% depending on the quality of their holdings and the amount of leverage they employ. More than three quarters of all the closed-end national municipal bond funds employ leverage and the amount of leverage ranges from 25%-50% depending on the fund.

Leverage (and the higher yield it delivers) is one of the key reasons for investors to choose a closed-end fund over the iShares S&P National Municipal Bond ETF (NYSEARCA:MUB), mutual funds, or holding individual bonds. With MUB currently yielding 3.69%, it yields less than all but one of its closed-end cousins. The average yield of the 25 unleveraged closed-end national municipal bond funds is 5.78% and the average for the leveraged ones is over a full percentage point higher at 6.86%.

There over 107 closed-end national municipal bond funds to choose from and back in November-December of last year, most traded at discounts to net asset value in excess of 10%. Granted discounts in that time frame were unusually high, but they have shrunk dramatically as investors have scoured the landscape for yield.

As of 8/19/09, only 70 of these funds traded at a discount to net asset value and the average discount is now just -1%, which is unusually small, meaning that, at least compared to their long-term history, these funds are now expensive (find the discounts to NAV at etfconnect.com).

Still, with government debt yields so low, it would not be surprising to see this situation continue until even more of these funds trade at par.