9% Yields Still Available on Municipal Bond Funds 16 comments
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I frequently get asked by individual investors how they can earn more money on their cash. With interest rates of traditional savings vehicles such as money market accounts, money market mutual funds, and CDs all paying from 0.5% to 2% annually where should an investor look? My answer inevitably is that to earn significantly higher yields one needs to look beyond government insured deposit accounts and similar vehicles and consider corporate debt, foreign government debt, and municipal debt. While we hold LQD (investment grade corporate bond ETF), and HYG and JNK (high yield corporate bond ETFs) in many client accounts, I often buy municipal bond funds as a way to put uninvested cash to work.
The iShares National Municipal Bond ETF (MUB) is currently yielding 5.60% on a taxable equivalent basis (35% marginal tax rate – non-taxable yield is 3.64%) over three times the 1.71% average yield on 1 year CDs! If you are willing to endure even more risk, higher yields are available through leveraged closed-end muni bond funds. In the table below are 28 leveraged closed-end muni bond funds (1) with assets over $100M (2) that are all delivering taxable equivalent yields over 9% and (3) pay monthly dividends that (4) have been stable or increasing over the last 12 months and (5) trade at a discount to their net asset values (all data from www.cefconnect.com as of 10/8/09).
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Disclosure: Long LQD, HYG, JNK, and NZF.
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You forgot to mention several downsides:
1.) The Expense Ratios are high - 1% or higher - this is 15% of a 6% pre-tax yield (9% tax equivalent yield)
2.) These are CEFs - the discount could get a lot lower. Because CEFs do not trade at NAV, they can sometimes act like a roach motel. They have poor liquidity.
3.) These CEFs make their "high profits" while overcoming high Expense by using leverage. The leverage strategy normally involves a maturity mismatch. Not a bad idea to borrow short at 1% and lend long at 6%. The problem is that when short interest rates rise above 6%, these guys will be left holding the bag. Leverage is profitable, but risky.
I like your ideas. If you can show me a low cost ETF that employs a leveraged strategy, I would be very interested.
I have LQD, HYG, and JNK. Though there are some fees involved, the returns have been very good. Given I bought these in April, all 3 have gone up considerably, so not only did I get the dividends, I also captured a lot of capital gains. I am now thinking that the market is likely to slow down some or flatten completely, so I plan on giving up on LQD. I have another investment that will pay 11% with principal protection. I might lose some on cap gains, but at this stage I want to play it safe. I will keep HYG and JNK.
On Oct 09 08:31 AM Living4Dividends wrote:
> The leveraged Muni bond fund is an interesting concept.
>
> You forgot to mention several downsides:
> 1.) The Expense Ratios are high - 1% or higher - this is 15% of a
> 6% pre-tax yield (9% tax equivalent yield)
> 2.) These are CEFs - the discount could get a lot lower. Because
> CEFs do not trade at NAV, they can sometimes act like a roach motel.
> They have poor liquidity.
> 3.) These CEFs make their "high profits" while overcoming high Expense
> by using leverage. The leverage strategy normally involves a maturity
> mismatch. Not a bad idea to borrow short at 1% and lend long at 6%.
> The problem is that when short interest rates rise above 6%, these
> guys will be left holding the bag. Leverage is profitable, but risky.
>
>
> I like your ideas. If you can show me a low cost ETF that employs
> a leveraged strategy, I would be very interested.
On Oct 09 09:40 AM felixjj wrote:
> Gotta ask, what investment pays 11% with principal protection? annuity?
Very informative article. I have been using these funds a lot and do own NZF as one you mention above. There are some of these funds with lower costs but may have different characteristics as well. One is MUA. It has cost of .69%, provides 9.8% yield and is only leveraged 3.8 %. It has lower quality bonds but that is relative. I treat these more or less just like stocks. If they are hurt when rates finally rise, I will sell them but I have held them for many months now. I also hold Insured Muni's that pay a bit less but are very stable and have been around since 1993. (IMT, IIM)
Thanks,
Willydo
On Oct 09 12:44 PM Dotcom wrote:
> How can I see the fees/expenses for a specific ETF? I'm looking
> at Yahoo Finance symbol LQD as an example. Thanks for any help.
Why are closed in Muni Funds selling off today? NZF is off 3.5%. I see dividends are coming out next Tues but I have not seen these funds drop this much before. Is anything else going on? (IMT, IIM, NZF, MUA)
Thanks,
Willydo
The main risk with these funds is that they are benefiting now from an environment of very low short term interest rates, so that the cost of leverage is extremely low - less than 0.5% according to Nuveen's latest figures. When the Fed stops pushing down short term rates, the cost of leverage may very well triple. And if long rates go up, these funds will face a double whammy, because the value of their portfolios will go down.
On Oct 09 02:52 PM Garrett Beauvais wrote:
> On Yahoo! Finance choose "ETF profile" from the navigation in the
> right column: finance.yahoo.com/q/pr... -- look on the
> bottom left under "Fund Operations" -- LQD has an expense ratio of
> 0.15% which is among the lowest for ETFs (about the same as treasury
> ETFs and far less than 0.4% for JNK and 0.5% for HYG).
On Oct 09 03:56 PM willydo wrote:
> Garrett,
>
> Why are closed in Muni Funds selling off today? NZF is off 3.5%.
> I see dividends are coming out next Tues but I have not seen these
> funds drop this much before. Is anything else going on? (IMT, IIM,
> NZF, MUA)
> Thanks,
> Willydo
Though nothing is 100% protected in this world, UBS has been offering "structured products" for individual stocks that have paid 8 to 11% annually with protection from 25 to 40%, meaning the stock can go down 25 to 40% before you have any risk.
Example,
This month, I am going to buy one of these structured products for Amazon. The return will be 10%, the term is 6 months, and as long as the underlying stock does not drop 25% or more, I get 100% of my principle back. If it does drop 25% or more, I will get the underlying stock at market price on the close of the contract. The interest is paid monthly for some, quarterly for others. The terms vary from 6 months to 2 years. I have had about 20 of these so far, and even during the big market drop in March, I did not have any default to paying in shares of stock due to a drop below the protection limit.
UBS has dozens of these for index's and commodities, though I tend to stay away from these as they do not pay as well.
Each month UBS offers several individual stocks with similar conditions. Also UBS is not necessarily the holder of them, they broker from other banks as well. They are not FDIC insured though, so you have to weigh that with your risk tolerance.
I have about 7% of my portfolio in these structured products, and since I now have quite a few, some come due every month and I roll them over into new contracts. The only gripe I have about them is the closeout date is generally the end of the month. To get new ones you have to purchase them by the middle of the month, with a strike date around the 25th of the month. Net, if one comes due, you cannot get the money reinvested until the next month, thus losing a month. I have worked with this by parking the money in another investment for the month so I am not losing out on the return.
The principle protection by the way includes the fee. You will get your 100% back at the end of the term, not 100% minus fee.
Personally I could care less about the fee. JNK is paying over 10%, the fee is very small in comparison.
I own JNK, HYG, LQD, again not a large part of my portfolio, but enough to get a pretty good cash return every month.
On Oct 10 01:23 PM Garrett Beauvais wrote:
> Why all longer term interest bearing vehicles (bonds) got hammered
> yesterday: tinyurl.com/yjjnulv (Bloomberg).