Over the past few years, various analysts have brought up concerns over municipal bonds, starting famously with Merideth Whitney calling for "50 sizable defaults, 50 to 100 sizable defaults, (or) more" during an appearance on 60 Minutes, back in 2011.
So far, these concerns have been largely unfounded. Yes, there have been some notable defaults, (namely Detroit, but also Harrisburg, PA, and Stockton, CA) but for the most part investors in municipal bonds are in good shape, thanks to municipalities having the ability to tax their way out of their predicaments or by cutting spending. Cities are becoming more and more aware of possible liquidity issues in the future as well, and are taking proactive measures now, before things get too difficult.
Muni bonds face another headwind, and that's the risk of increasing interest rates. It seems unlikely the fed is going to taper stimulus any time soon, but we all know rates really only have one direction to go, and that's up. Rising rates will cut the price of any municipal bond funds. It's only a matter of time. I think investors have a couple of years before they really have to worry about this happening in any substantial way, but predicting interest rates is difficult even for people much smarter than me.
Here are 5 closed end funds that all hold muni bonds, and all use leverage to enhance their returns. Thanks to the market getting spooked by potentially rising rates, these have all fallen to close to 52 week lows, giving investors an opportunity to get yields approaching 8%. Leverage does add risk, giving investors a double amount of hurt if things go badly.
All information taken from Morningstar.
1. Pioneer High Income Municipal Trust (NYSE:MHI)
- Current price: $13.81
- Current distribution: $0.095/monthly
- Current yield: 8.25%
Up first is the Pioneer High Income Municipal Trust CEF, managed by Pioneer Investments, who charge a 1.03% management fee. The fund has a market cap of $311.8M and trades an average of 63,185 shares per day, making it liquid enough for most investors. The fund has maintained the 9.5 cent monthly distribution since April of 2011, when it raised distributions from 9 cents monthly. The fund hasn't missed a distribution since inception in 2003, and hasn't returned any capital to investors over any of the past 5 years.
A couple of things to be a little concerned about with this fund is it trades at a small premium to NAV (7%), which it has consistently for the last few years. The fund also uses approximately 25% leverage to enhance returns, and average duration of their bonds is over 12 years. Morningstar currently ranks it a 4 star fund.
2. Nuveen Municipal High Income Opportunity Fund (NYSEMKT:NMZ)
- Current price: $11.57
- Current distribution: $0.073/monthly
- Current yield: 7.57%
Batting second is the Nuveen Municipal High Income Opportunities Fund, a CEF managed by Nuveen Investments, who charge a 1.42% management fee. The fund has a market cap of $329.5M and trades an average of 76,059 shares per day, an adequate amount of liquidity. The fund has maintained a distribution of 7.3 cents per month since September, 2011, after the fund cut the distribution from 8.35 cents. The fund hasn't missed a distribution since inception in 2003.
The fund trades at a 5.4% discount to NAV, after spending much of the last 5 years trading at a premium to NAV. The fund uses approximately 27% leverage, and the average duration of their underlying bonds is 10 years. Morningstar currently ranks it as a 4 star fund.
3. Dreyfuss Municpal Income Inc. (NYSEMKT:DMF)
- Current price: $8.19
- Current distribution: $0.0525/monthly
- Current yield: 7.69%
In the third spot is the Dreyfuss Municipal Income Fund, a CEF managed by Dreyfuss, a subsidiary of Mellon Corp, who charge a 0.93% management fee. The fund has a market cap of $169.6M and trades an average of 55,149 shares per day, making it the least liquid fund so far. The fund has maintained a distribution of 5.25 cents per month since December of 2010, when they increased the distribution from 4.75 cents per month. The fund hasn't missed a distribution since inception in 1991, but has periodically cut and increased the distribution over the years as management has seen fit.
The fund trades at a 8.49% discount to NAV after spending much of the last 2 years trading at a 4-8% premium over NAV. The fund uses approximately 28% leverage, and has an average duration to maturity of just 6.5 years, making it the least sensitive to interest rates out of the funds we've looked at so far. Morningstar ranks it as a 3 star fund.
4. BlackRock LT Municipal Advantage Trust (NYSE:BTA)
- Current price: $10.02
- Current distribution: $0.062/monthly
- Current yield: 7.43%
Fourth on the list is Blackrock's LT Municipal Advantage Trust, managed by BlackRock Investments, the same company behind the iShares family of ETFs. They charge a 1.55% management fee, although they've adjusted that downwards to 0.92%, at least in 2013. The fund has a market cap of $134.5M and trades 47,527 shares on an average day. The fund has maintained the distribution of 6.2 cents per month since September 2012, when they cut it from 6.6 cents per month. The fund hasn't missed a distribution since inception, which was in 2006.
The fund trades at a 10.2% discount to NAV, the largest discount since 2009. The fund uses approximately 40% leverage, making it the riskiest of the ones profiled today, at least from that perspective. Morningstar doesn't list an average bond duration length for the fund, but does tell us that 78% of holdings are longer than 20 years in length. Morningstar ranks it as a 3 star fund.
5. Putnam Managed Municipal Income Trust (NYSE:PMM)
- Current price: $6.57
- Current distribution: $0.0389/monthly
- Current yield: 7.11%
Rounding out the list is the Putnam Managed Municipal Income Trust, managed by Putnam out of Boston. Putnam charges a 0.89% management fee. The fund has a market cap of $379M and trades an average of 163,520 shares per day, giving the most liquidity out of the 5 CEFs. The fund has maintained a distribution of 3.89 cents per month since December of 2011, after cutting the distribution from 4.4 cents per month. This fund has been around since 1989, not missing a distribution this whole time.
The fund trades at a discount of 9.44% of NAV, quite a bit lower than the three year average discount of 0.95%. The fund uses 20.9% leverage and has a average bond duration of 6.67 years, only giving it intermediate interest rate exposure, according to Morningstar. The same company gives it a 2 star rating.
As long as you're willing to take a little extra risk and add some leverage to your muni bond exposure, you can get tax free returns of over 7%, plus the potential for capital gains if interest rates stay low for the foreseeable future. Investors looking for income can do a lot worse.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Certain family members have a position in DMF.